Royal Dutch Shell PLC (LON: RDSA) – Having strong cash generation to grow business and increase shareholders distribution.

Royal Dutch Shell PLC is a FTSE 100 listed Petrochemical and Energy Company which is involved in the exploring, producing, refining, and marketing of oil and natural gas. The Integrated Gas segment is engaged in activities related to liquefied natural gas, and the conversion of natural gas into gas-to-liquids fuels and other products. The Downstream segment is involved in manufacturing, marketing, and trading activities of oil products and chemicals, that converts crude oil and other feedstocks into a range of products which are moved and marketed around the world for domestic, industrial and transport use. The Upstream segment combines the Upstream and Oil Sands segments.

On 4 February 2021, Royal Dutch Shell will release its fourth quarter results for FY20.

 (Source: Annual Report, Company Website)

Growth Prospects and Risk Assessment

Shell is likely to continue its relentless high grading of the portfolio with expected divestment proceeds of $4 billion a year on average. Following the Q3 FY20, it reported reduced debt and increased distribution to shareholders. Shell’s decisive steps this year have significantly strengthened its financial resilience, allowing the acceleration of strategic plans and providing clarity on cash priorities. Shell’s sector-leading cash flows is to grow the businesses of the future while increasing shareholder distributions, making the entity a compelling investment case. The cash allocation framework includes a target to reduce net debt to $65 billion (from $73.5 billion as of 30 September 2020). It also aims to be a net-zero emissions energy business by 2050 or sooner, as it has further developed the integrated power business and commercialised hydrogen and biofuels to support customers’ efforts to achieve net-zero emissions.

However, there are certain risk and uncertainties to business growth. The volatility of commodity prices is likely to impact the earnings and cash flow from operations. Also, there is risk associated with climate change, legislative, fiscal and regulatory developments, economic and financial market conditions, risks associated with the impact of pandemics, and unfavourable foreign exchange and interest rates movement.

Industry Outlook Dynamics

As per the report from Allied Market Research, the global renewable energy market is expected to reach around US$1,512.3 billion by 2025 from US$928.0 billion in 2017. However, there are various factors which will drive the overall global energy demand such as

• The global population is projected to increase from 1.7 billion in 2019 to 9.2 billion in 2040.
• The global economy is likely to double in the next 25 years. Hence, the rising energy demand for economic activities.
• Increasing awareness towards climatic change and carbon emission.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Royal Dutch Shell Plc.

Recent Developments

On 4 January 2021: The Company announced that the EU Home Member State of Shell for the regulatory purposes of the EU Transparency Directive would be the Netherlands. This decision has taken due to the ongoing exit of the United Kingdom from the European Union.

On 31 December 2020: RDSA confirmed that it consists 4,101,239,499 in A shares and 3,706,183,836 in B shares, with equal voting rights. It does not hold ordinary shares in treasury. Therefore, the total number of A shares and B shares in issue stood at 7,807,423,335.

On 21 December 2020: The Company stated that QGC Common Facilities Company Pty Ltd (a wholly-owned subsidiary of Shell) has agreed to the sale of a 26.25% interest in the Queensland Curtis LNG Common Facilities to Global Infrastructure Partners Australia, which is for a consideration of US$2.5 billion.

A Glimpse of Business Segments (Q3 FY20)

Trading Update (regarding the fourth quarter 2020 outlook, as on 21 December 2020)

• In Integrated Gas, the Company expects production to be in the range of 900-940 thousand barrels of oil equivalent per day and LNG liquefaction volumes to be between 8.0 and 8.6 million tonnes.
• In Q4 FY20, the integrated gas earnings impact was limited due to PSC effects, despite the increased production (against Q3 FY20).
• In the fourth quarter of 2020, the significant margining outflows have impacted the CFFO (Cash Flow From Operations) as compared with margining related inflows at the end of the 2020 third quarter.
• In the current price environment, the adjusted earnings are expected to show a loss in the upstream division. While, the upstream production is expected to be in the range of 2,275-2,350 thousand barrels of oil equivalent per day.
• The Company expects realised upstream gas prices to be in line with Henry Hub.
• The depreciation in upstream business is expected to be US$100 to US$200 million, which will be higher from the third quarter of 2020, and upstream tax charges will be in the range of US$600-US$900 million.
• In oil products division, the Company expects refinery utilisation to be between 72% and 76%, realised gross refining margins to be slightly improved (compared with Q3 FY20), sales volumes to be between 4,000 and 5,000 thousand barrels per day, marketing results to be in line with Q4 FY19, and trading & optimisation results to be significantly lower (compared with Q3 FY20).
• In Chemicals business, it expects manufacturing plant utilisation to be in the range of 77%-81% and sales volumes to between 3,600 and 3,900 thousand tonnes. While, the Chemicals base and intermediate margins to improve as compared with Q3 FY20.
• In Q4 FY20, the Corporate segment adjusted earnings are expected to be a net expense of US$900 to US$975 million.

Q3 FY20 and 9M FY20 Trading Update (for the period ended 30 September 2020, as on 29 October 2020)

(Source: Company Website)

• In Integrated Gas division, the Company has made a joint venture with CrossWind consortium during the quarter and was awarded the tender for the subsidy-free offshore wind farm Hollandse Kust in the Netherlands.
• In Q3 FY20, the Company witnessed an improvement in performance from all the businesses, the revenue increased versus Q2 FY20, while it remained below Q3 FY19 data.
• Income attributable to Royal Dutch Shell shareholders stood at US$0.5 billion for Q3 FY20, which reflected lower realised prices for LNG & oil, as well as lower realised refining margins and production volumes compared with the corresponding period of the last year. However, the Company has given the profit in Q3 after making a loss in the Q2 period.
• In Q3 FY20, the adjusted earnings were US$1.0 billion, which has shown an increase from the previous quarter.
• Cash flow from operating activities increased to US$10.4 billion in Q3 FY20 against the previous quarter, which included positive working capital movements of US$1.4 billion.
• Led by strong cash flow generation, the gearing decreased to 31.4% at the end of Q3, compared with 32.7% at the end of Q2.
• The Board announced an interim dividend in respect of Q3 FY20 of 16.65 US cents per A ordinary share and B ordinary share.
• Further, the Company had completed the sale of the US Appalachia shale gas position to NFG Midstream Covington, LLC and Seneca Resources Company, LLC. The consideration amount of US$541 million (less closing adjustments) was paid fully in cash.
• During Q3 FY20, Shell witnessed a strong contribution from crude and oil products, capacity optimization, and lower operating expenses, which will help them to overcome the uncertain times.

Share Price Performance

On 6 January 2021 (before the market close, at 8.25 AM GMT), Royal Dutch Shell shares were trading at GBX 1,416.80, up by 1.81% against the previous day closing price. Stock 52-week High and Low were 2,338.59 and GBX 878.10, respectively.

From the technical standpoint, 50-day SMA (1248.80), and 20-day EMA (1341.70) are currently supporting an upside potential, which means the stock price could increase in the short term.

In the past six months, RDSA’s share price has delivered ~8.10% return as compared to the ~6.07% return of FTSE 100 index, and a negative ~0.77% return of FTSE All Share Resources index, which shows that the stock has outperformed the benchmark index and the sector.

In the last three months, Royal Dutch Shell Plc share price has delivered around 45.32% return as compared to approximately 11.26% return of FTSE 100 index, which shows that the stock has outperformed the index during the last three months.

Valuation Methodology: Price/Cash Flow Approach (NTM) (Illustrative)

Business Outlook Scenario

Shell is likely to continue strong capital discipline, including a focus on reducing net debt and annual Cash capex of between US$19 and US$22 billion in the near term. However, the challenges presented by Covid-19 is likely to impact the demand for oil, gas, and related products in Q4 FY20. The fourth quarter 2020 outlook provided ranges for operational and financial metrics are subject to change in the light of current evolving market conditions:

• The production of integrated gas expected to be approximately 900 - 940 thousand boe/d.
• LNG liquefaction volumes are expected to be approximately 8.0 - 8.6 million tonnes.
• Upstream production is expected to be approximately 2,275 - 2,350 thousand boe/d.
• Chemicals manufacturing plant utilisation is expected to be approximately 77% - 81%.
• Refinery utilisation is expected to be approximately 72% - 76%.
• Corporate segment Adjusted Earnings are expected to be a net expense of $900 to $975 million for the fourth quarter.

For long-term, Shell is continuously investing in generating power from natural gas and renewable sources. It is confident that its integrated business model and high-quality assets will help them to overcome uncertain times. Hence, the Group looks attractive and has the capability to sustain for the long term.

(Source: Presentation, Company Website)

Considering the decent operating and financial performance, sustainable business model, robust cash generation, lower net debt, improved profitability margins, positive working capital movements, a target of net-zero emissions energy business by 2050, consistent dividend payout trajectory from the last 13 years, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Royal Dutch Shell at the current price of GBX 1,416.80 (as on 6 January 2021, before the market close at 8:25 AM GMT), with lower-double digit upside potential based on 4.49x Price/NTM Cash Flow (approx.) on FY21E cash flow per share (approx.).

 

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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