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Royal Dutch Shell In The Clear

: Aug 23, 2017


  • Shell’s latest quarter was marked by successful cost reductions and acquisition-related synergies.
  • Shell seems to be able to meet its cash flow obligations without much trouble.
  • I recommend Shell for income investors, but with a few caveats.

Back on May 24th I “sounded the all clear” on Royal Dutch Shell (RDS.A) (NYSE:RDS.B). Shell, I felt, would henceforth be able to pay its dividends and capital expenditure from operational cash flow. Shell’s latest quarter was another continuation of that, with ongoing synergies from the huge BG Group acquisition two years ago and also continued opex savings. Shell’s pro-forma workforce is about 30% smaller than it was in the beginning of 2016, and while that may not be good for employees who were laid off, it is a reflection of impressive modernization and productivity gains from the company itself.

This article takes a look at Shell’s ongoing cost-saving measures. This article also looks at the company’s updated cash flow situation, its dividend safety, and finally its valuation.

Building on its success

Shell had a pretty good quarter. There’s no bang-up production increases such as the likes of what we saw in BP (BP) or Chevron (CVX). In fact, production was just about flat.

Courtesy of Royal Dutch Shell Investor Relations.

As you can see above, production growth was offset by decline, turnarounds and the continuing decline in the Netherlands offshore gas assets. Asset sales also contributed to keeping production flat. Shell isn’t meaningfully growing production. The most noteworthy takeaway from the second quarter is cost reductions and ongoing synergies from the BG acquisition. Let’s have a look at that.

Courtesy of Royal Dutch Shell Investor Relations.

You can see above that opex has been going in one direction for the last few years: down. Some of this is to be expected with a significantly lower oil prices. I’ve said this in a previous article on BP, but it bears repeating here: Even though cost inflation is starting to pick up in the shale, that is absolutely not happening in offshore, at least not yet. Rig dayrates are stable and very low, total costs of drilling continue to drop, and modernization, automation included, is reducing costs of operation.

In this case, Shell has made seven ‘Shell Business Operation’ centers, and this has allowed for standardization of technology, business practices and operations across the board. All of these forces have combined to save some $8 billion-$10 billion in operating expenses, much of which I believe will ultimately be permanent.

Synergies chart courtesy of Shell Investor Relations.

Since the 2015 acquisition of BG Group, Shell has methodically set about combining the two companies’ operations, high-grading the portfolio and streamlining things. Results are really starting to show. Already there has been some $2.5 billion in cost synergies, and that’s pretty much about as good as it’s going to get. There will be some additional exploration synergies, much of which, I believe, comes from high-grading the portfolio and getting rid of assets that can no longer compete for capital within the combined company.

All that led to some pretty good cash flow numbers. Shell generated $11.2 billion in operating cash flow over the last quarter, $5.6 billion of which went to capital expenditure. That leaves $5.6 billion in free cash flow, of which $2.9 billion went to dividends. This means Shell had an excess of $2.7 billion left over at the end of the quarter. Not bad at all.

Can Shell keep it up? I believe so. Consider the following: Management expects to spend somewhere between $25 billion and $30 billion annually in capex until 2020. With crude oil as it is right now, that number is going to be closer to $25 billion. For simplicity’s sake, let’s assume $25 billion in the following calculation. Over the last twelve months Shell has generated $38 billion in operating cash flow. Let’s also assume that it does the same in the next twelve months (I believe Shell will do better).

That means $13 billion in free cash flow, and the dividend is typically $10.5 billion per year. That does not figure in further operating cost savings, which I believe will continue.

Worth a shot

Courtesy of Google Finance.

This is a five-year chart of common shares. We can see that shares have made a slow, gradual recovery. Even here Shell still yields an eye-catching 6.87%. In the past I’ve cautiously recommended Shell, and I’d like to do so once again in this article. I do like Shell, and I do like its cost-saving efforts as well as its integration of BG Group – an acquisition which is starting to payoff in spades.

However, Shell’s cost reduction and savings are by no means unique. Most other integrated oil companies have been able to achieve similar results. As I’ve said in previous articles, I like Exxon Mobil (XOM) best even though it has a smaller dividend yield. Shell’s total outstanding debt is nearly 2 times EBITDA, while Exxon’s is at 1.2 times. Exxon also has the highest credit rating in the industry. If you’re looking for stability, and a company that has been able to acquire consistently into these low oil prices, then I think Exxon is the way to go. If you’re looking for yield, as many income investors surely are, Royal Dutch Shell is a good pick to make.

If you’re interested in Shell, feel free to follow me here on Seeking Alpha. I’ve been following Shell for awhile and will continue to write update articles when doing so is both material and relevant. Also, I have a Marketplace service which allows me to write broader market articles tailored to income investors, which would not otherwise fit well into the ‘free’ article format. I encourage you to look at that as well.

Disclosure: I am/we are long RDS.A.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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