Shell Misses Its 4Q’16 Earnings Estimate, But Delivers Well On Its Operational Strategy

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RDSA: Royal Dutch Shell logo
RDSA
Royal Dutch Shell

Royal Dutch Shell (NYSE:RDS.A), following the footsteps of its competitors, Exxon Mobil and Chevron, missed the consensus earnings estimate for the December quarter of 2016((Royal Dutch Shell Announces December Quarter 2016 Results, 2nd February 2017, www.shell.com)). The integrated energy company also failed to meet the analyst estimate for 4Q’16 revenue, despite showing strong recovery in the top-line, both on a sequential as well as on an annual basis. That said, the oil and gas major was able to reduce its operating costs for the year to around $39 billion, almost $10 billion lower compared to the costs (including BG Group deal) in 2014. Further, the company also outperformed its capital expenditure guidance by restricting its spend to only $27 billion, almost $2 billion lower than its target for 2016. Thus, we figure that Shell managed its operations and cash flows efficiently during the year, and exceeded its goals for the year. As a result, even after missing the revenue and earnings expectations, the company’s stock did not plunge, unlike its peers, who saw a sudden drop in their price, soon after posting less-than-expected results.

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Key Highlights Of Shell’s 4Q’16 Results

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The year 2016 was a transitional one for Shell, as the company completed its acquisition of BG Group. Due to the integration of BG’s results, the Netherlands-based company saw a sharp jump in its production volumes through the year. However, unlike its rivals, Shell did not see much of an uptick in its upstream price realizations in the second half of 2016, despite the recovery in commodity prices. This was primarily because a significant portion of the company’s upstream revenue is dependent on gas or LNG prices. While LNG prices move in tandem with oil prices, there is a bit of a time lag in the pricing of the two commodities. As a result, the higher production from BG acquisition was partially offset by weak gas prices during the fourth quarter. However, Shell saw an increase in the downstream sales volumes, both for refined and chemical products. Thus, the oil and gas producer managed to post a notable rise in its revenue for the last quarter, sequentially as well as annually. Yet, the company missed the consensus revenue estimate for the quarter by almost $5.8 billion.

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On the cost side, Shell saw a drastic turnaround in its integrated gas and upstream operation, driven by the BG Group deal and the rebound in commodity prices. The company reported adjusted earnings of $961 million from its integrated gas and upstream divisions in the December quarter, which is significantly higher compared to the adjusted income of $236 million recorded in the same period of 2015. However, the impact of improved results from the two segments was partially offset by the lower-than-expected performance from the company’s downstream operations. This weak performance was a result of declining refining margins, which more than offset the strong chemical margins during the quarter. Thus, Shell was unable to satisfy the market as it posted adjusted net earnings of 44 cents per ADR for the fourth quarter, which is sizeably lower on a year-on-year and quarter-on-quarter basis.

Efficiently Pulling The Levers

That said, on a full year basis, Shell outperformed its guidance for cost reduction for the year. Based on its 2020 strategy, the company aimed to bring down its operating costs (including the BG Group) to around $40 billion by the end of 2016. However, due to its consistent efforts, the company managed to book operating expenses of approximately $39 billion for the fiscal, nearly $1 billion lower than expected. During the year, Shell reduced its workforce by around 6,500, ahead of the target of 5,000, which helped the company to save a notable portion of the salary costs. Further, the company moved out from its offices in Houston and London to curb its rental and overhead costs. Further, the successful integration of the BG operations enabled the company to realize higher-than-anticipated synergies during the year, which augmented the company’s cost cutting initiatives. Given the extraordinary results from its cost control measures, Shell aims to keep its operating costs under $40 billion over the next couple of years.

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Not only did it over-perform on the cost front, the European company also saved about $2 billion from its capital spending budget for the year 2016. This allowed the company to manage its diminishing cash flows more efficiently and deliver higher returns to its shareholders. Going forward, Shell will continue to spend between $25 billion and $30 billion each year until 2020 and focus on enhancing the economic viability of its existing assets and investing on high-margin projects to boost its future value.

In addition to this, Shell will concentrate on optimizing its existing portfolio by divesting non-core and non-strategic assets, while deriving an attractive value for those assets. The company expects to complete asset sales of roughly $30 billion in the time period of 2016-2018. In line with this strategy, the oil and gas company closed divestments of $5 billion in 2016, and has recently announced deals of another $5 billion to be closed soon. Also, the company is in further talks for other such sales. Thus, we believe that the company is progressing well on achieving its divestment program over the next two years.

Lastly, Shell has a strong pipeline of new projects that are either operational or are expected to come online over the next two to three years. These projects are estimated to produce more than 1 million barrels per day by 2018, and operate at cash operating costs of less than $15 per barrel of oil equivalent (boe). As a result, the company expects to generate cash flows of approximately $10 billion from these projects by 2018, assuming a tax rate of 35%. Hence, these projects will drive the company’s future growth. Overall, we believe that Shell has laid down an extensive strategy for the next few years that will enable the company to reshape its operations and emerge out of the ongoing commodity slump.

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