Royal Dutch/Shell Steams Down Recovery Road August 5, 1999
Anglo-Dutch integrated oil and gas giant Royal Dutch/Shell Group, which is 60% owned by Royal Dutch Petroleum (NYSE: RD) and 40% owned by Shell Transport & Trading (NYSE: SC), continued its turnaround story today by reporting second quarter earnings of $1.6 billion (excluding special items), up 5% from a year ago. The results topped the expectations of analysts, many of whom had figured the company's earnings would decline during the quarter along the same lines as its fellow international oil giant brethren. But thanks to aggressive cost-cutting measures and higher crude oil prices, Royal Dutch/Shell is proving that its current situation is unique.
Over the past six months, oil prices have nearly recovered from a gut-wrenching, 15-month long slide that lasted from October 1997 to December 1998. New York crude prices bottomed out at close to $10 a barrel just before Christmas but have nearly doubled since then and closed at $20.44 a barrel yesterday. That's good news for the major integrated firms, whose most profitable business lines are oil and gas exploration and production (E&P). But the effects of the price recovery will take some time to fully show up in the form of higher earnings.
Exxon (NYSE: XON), Mobil (NYSE: MOB), and other U.S. integrateds have posted Q2 year-over-year earnings declines as they try to crank up the E&P businesses again to pick up the slack from their refining operations, whose profitability heads south as oil prices head north. The transition will take some time, however. Royal Dutch/Shell has not been immune to this trend, and its refining margins are being squeezed as well. Margins in Europe have slumped to $0.60 a barrel from $2.30 a barrel a year ago, Asian margins have eroded to $0.40 a barrel from $1.90 a barrel, and U.S. margins have been chopped in half to $2.10 a barrel from $4.20 a barrel.
However, the refining margin slide has been more than offset by the firm's cost-cutting initiatives, which were undertaken last year by Managing Directors Committee Chairman Mark Moody-Stuart as the threat of increased competition among the so-called "super majors" became all too real. While rivals BP Amoco (NYSE: BPA) and Exxon were busy looking for ways to increase their scale through mergers, Royal Dutch/Shell took the opposite tack and started to shed some of its less-profitable businesses. As a result, total long-term assets have fallen 5% from a year ago.
Simultaneously, the company has reined in costs and slowed its capital spending program, which declined 26% from a year ago. Thanks to cost-cutting, adjusted E&P profits surged 62% from a year ago to $819 million. Return on average capital employed, the industry's standard profitability metric, came in at an annualized rate of 7.2% during Q2. That's probably not high enough to beat Royal/Dutch Shell's cost of capital, but overall profitability should improve later in the year as the higher oil prices begin to have a more dramatic effect on E&P earnings.
Royal Dutch/Shell still has a great deal of work to position itself as the oil company to beat for the foreseeable future. "I am not about to tell you that we have 'turned the corner' or anything like that," Moody-Stuart said cautiously. But with its business looking better than it has in recent memory, and the cost-cutting efforts in full swing, it may not be long before Royal Dutch/Shell sets itself apart from the pack again and shifts from restructuring mode to growth mode.
Brian Graney (TMF Panic)