Investors Should Prepare for a Slimmer Royal Dutch Shell

Shell plans $15 billion worth of asset sales by the end of 2015. If it isn't careful, its massive divestments may endanger future growth.

Feb 26, 2014 at 9:30AM

Integrated energy majors like Royal Dutch Shell (NYSE:RDS-B) and ExxonMobil (NYSE:XOM) are in a bind. Upstream profits disappointed last year, despite relatively supportive oil and gas prices. That was due to disappointing exploration and production. On the downstream side, shrinking margins on refined product sales resulted in collapsing profits in that segment across the industry.

While these energy powerhouses have promised a return to growth, it's hard to imagine how that will be accomplished given the severe asset sales currently swirling throughout the sector. In particular, Royal Dutch Shell's particularly harsh divestitures will make it extremely difficult to get profits growing in the short-term. That may make its plan to increase dividends amount to little consolation for growth-starved investors.

Shell shears its downstream business
Since the start of 2014, Royal Dutch Shell has announced a series of divestments focused in its downstream business. This isn't entirely surprising, since Shell's downstream segment posted a 16% drop in earnings in 2013. In response, Shell management notified investors it would embark on an era of strict capital discipline. This would involve making difficult decisions about which assets to keep and which assets to unload, with the broader goal of increasing Shell's efficiency and productivity.

Recently, Shell reached agreements to sell downstream assets in Italy and Australia. The deal to divest its Australian assets fetched $2.6 billion, so it's clear that these sales are significant. Shell has taken great steps to divest downstream assets across the world. In recent weeks, Shell has unloaded refineries in the United Kingdom, France, Norway, and Germany, and also sold various other downstream assets in Egypt, Spain, Greece, Finland, and Sweden.

Consistent with the strategy
Throughout the process, Royal Dutch Shell management maintains that the asset sales are consistent with its overarching strategy to become a much more concentrated company. In all, Shell wants to divest a total of $15 billion worth of assets by 2015, which is a level much greater than its peers. On the downstream side, Shell wants to focus on a smaller overall number of assets and markets where it's an industry leader and most competitive.

Importantly, Royal Dutch Shell's strategy differs greatly from the strategy employed by its closest competitors. ExxonMobil's downstream performance was also poor last year, and yet, it isn't simply taking an axe to its portfolio. ExxonMobil's downstream profits collapsed by 74% last year, but the company is largely sticking with its existing operations. That's because it seems some light at the end of the tunnel. ExxonMobil expects some recovery in refining in the near-term. Management noted strengthening in global refining conditions in the fourth-quarter, so it's not taking such drastic steps as Royal Dutch Shell.

In fact, ExxonMobil's view is supported by some of the refiners themselves. For instance, Valero Energy (NYSE:VLO) also sees the tough refining conditions easing this year, driven by continued demand growth in the emerging markets. Valero management believes demand growth from developing economies to be crucial to refining, since refining is a global business. World growth impacts refiners in every market, and particularly strong growth in the Middle East and Asia will lead the recovery.

After its significant downstream divestments in Australia, Royal Dutch Shell risks missing out on the tantalizing potential of the emerging markets. Its refineries and other downstream assets in Australia were in an ideal spot geographically to serve the rapidly growing Asian markets.

Royal Dutch Shell risks future growth potential
While Royal Dutch Shell embracing financial discipline is admirable, selling off billions in assets will likely come at a cost to future growth. Last year was an extremely difficult one for the integrated majors, but Shell seems to be the only one panicking.

To compensate investors, Shell management intends to bump up its dividend by about 4% in the first quarter. That may amount to little consolation if underlying profits disappoint over the next several quarters. With such severe asset divestments under way, that scenario seems likelier by the day.

Trimming their dividend isn't likely in the cards for these companies either

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