BP vs. Shell – Who Has A Better Capital Structure?

by Trefis Team
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Royal Dutch Shell Plc.
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Depressed commodity prices over the last three years have deteriorated the profitability and cash flows of oil and gas companies worldwide. This has forced some of them to leave the markets, while the others have resorted to raising additional debt in order to sustain their operations. As a result, most of the oil and gas producers have a skewed capital structure and are struggling to meet their long term obligations and/or returning value to their shareholders. In the light of these factors, we compare two of the largest integrated energy companies – BP Plc. (NYSE:BP) and Royal Dutch Shell (NYSE:RDS.A), and analyze their financial position to find which of the two has a more sound and stable capital structure.

See Our Complete Analysis For Royal Dutch Shell Here

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Source: Company Filings

Debt-to-Capital Ratio

Despite being one of the largest European integrated energy companies, Shell has held a fairly low amount of debt on its books historically. Consequently, the company had a debt-to-capital ratio of around 18% in 2014, when the commodity downturn began. However, the company had to raise additional debt of almost $45 billion from the markets over the last couple of years in order to meet its capital spending and expansion needs. As a result, the company’s leverage shot up to almost 31% in 2016, bringing its three-year average to 24%.

On similar lines, BP raised additional debt over the last two years to bridge the gap between its cash inflows and outflows. Yet, the company’s long term obligations have grown by only $6 billion to $51.7 billion at the end of 2016. That said, BP’s shareholders’ equity has deteriorated significantly since 2014 due to its dwindling profitability. Accordingly, the company’s debt-to-capital ratio rose from 29% in 2014 to 35% in 2016, taking its three-year average to 32%.

Thus, on comparing the leverage of the two companies, we believe that despite having a notable rise in its long term debt, Shell continues to hold a more balanced capital structure than BP, and thus, has less pressure of repayment of debt in the current low price environment.BP-Shell-6

Debt-To-EBITDA Ratio

As mentioned earlier, the long term obligations of both BP and Shell have increased notably over the last couple of years. At the same time, the two companies have witnessed a sharp decline in their profitability and cash flows.

Now, on analyzing the data in the table below, we infer that BP’s profitability has plunged much more drastically as compared to that of Shell’s. Consequently, despite a small increase in long term debt, the company’s debt-to-EBITDA ratio has gone up from 1.36 in 2014 to 3.66 in 2016. On the contrary, even with a stark rise in its long term debt, Shell’s debt-to-EBITDA ratio has increased from 0.65 in 2014 to only 2.31 in 2016, since the company’s managed to sustain its profits through the downturn. In fact, Shell’s average debt-to-EBITDA ratio is almost half of that of BP’s, implying the former’s ability to meet its debt obligations is much higher compared to the latter. BP-Shell-7

Interest Coverage Ratio

Since the long-term debt of both the companies has gone up sizeably in the last two years, their interest payments has also increased remarkably. For instance, Shell’s interest obligations have almost doubled to $3.2 billion in a span of two years, while BP’s interest expense has increased from around $1.1 billion to about $1.7 billion in the same time frame. However, as described previously, BP’s profitability has taken a deeper hit compared to that of Shell’s. The former made operating losses (adjusted) of $3.7 and $0.4 billion in 2015 and 2016 respectively, while the latter improved its operating profits from $9.7 billion to $10.9 billion in the last two years.

On comparing the two companies in terms of their interest coverage ratio, we figure that the ability to service their interest obligations has dropped for both the companies. That said, since Shell continues to make profits at the operating level, it has a higher ability to meet its fixed obligations. In contrast, BP’s interest coverage ratio has deteriorated drastically in the last two years, indicating that the company may not be able to meet its interest expenses from its operational profits, which poses a risk to its debt-holders, if the commodity prices do not recover soon.

BP-Shell-8

Based on the discussion above, we believe that despite rising debt and declining profitability, Shell continues to hold a stable capital structure, and is operationally sound to repay its long-term obligations. In comparison, BP has a more levered balance sheet, and could run into the risk of defaulting on its debt repayments due to dwindling profits and cash flows, if the commodity slowdown persists longer-than-expected.

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