Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) has put together quite the streak of impressive earnings reports. This past quarter was no different. Not only did the company grow net income by 54% compared to the prior quarter, it is also generating loads of cash on top of its ambitious 2018 capital spending plans. 

With its business firing on all cylinders, investors might be a little curious why it hasn't started that ambitious share repurchase program that it promised investors quite some time ago. Let's take a look at the company's results, what it will take for management to shift gears to share repurchase mode, and why investors should be considering this stock today.

Shell's red-orange Prelude floating LNG facility

Image source: Royal Dutch Shell.

By the numbers

Metric Q1 2018 Q4 2017 Q1 2017
Revenue $89.2 billion $85.4 billion $71.8 billion
Net income $5.90 billion $3.81 billion $3.54 billion
Earnings per ADS $1.40 $0.92 $0.86
Operating cash flow $9.42 billion $7.27 billion $9.51 billion

DATA SOURCE: ROYAL DUTCH SHELL EARNINGS RELEASE. ADS = AMERICAN DEPOSITARY SHARES.

I think that, based on these results, it's fair to say that Royal Dutch Shell has really hit its stride in terms of earnings and cash flow. This was by far the best result the company has had since before the crash in oil prices. Much of that can be attributed to the recent rise in prices -- Shell realized oil and natural gas prices of $60.6 per barrel and $4.86 per thousand cubic feet, respectively -- but a lot of credit has to go to management for reworking its portfolio and drastically reducing costs to make $60 a barrel so profitable.

A couple of things that stand out in Shell's segmented results is a big uptick in earnings from its integrated gas and the surprisingly resilient results from its downstream segments (oil products and chemicals. Shell has made integrated gas and LNG sales a core pillar of the business, and it showed as it increased its total LNG sales volume 17.3% from last year to 18.58 million tons. On the downstream side of the business, you would typically expect earnings to decline significantly in a rapidly rising feedstock environment like we saw this past quarter, but chemical margins remained surprisingly high and it was able to offset weakness with refining margins that had high retail sales and commodity trading profits.

RDS earnings by business segment for Q1 2017, Q4 2017, and Q1 2018. Shows large increases for Integrated gas and upstream with modest declines in oil products and chemicals.

Data source: Royal Dutch Shell earnings release. Chart by author.

Asset sales and reconfiguring its portfolio have been core aspects of Shell's turnaround, and it continued that by closing $1.9 billion in sales between the beginning of the quarter and the day of the earnings release. Management also announced an additional $2.4 billion in sales, which puts it very close to its previously announced target of $30 billion in sales.

The highlights

  • Production for the quarter came in at 3.84 million barrels of oil equivalent per day (boe/d), which was up about 80,000 boe/d compared to the prior quarter. All of those gains came from higher natural gas production, which more than offset declines in oil production.
  • Management gave the green light to the Vito development on the U.S. side of the Gulf of Mexico. Ever since its presentation in November, it has made the final investment decision on eight offshore projects worldwide.
  • Shell announced it won nine offshore exploration blocks on the Mexican side of the Gulf of Mexico as well as four blocks in Brazil's most recent auction. Shell will be the operator on all of the Mexican blocks and the operator on two of the four in Brazil.
  • Management maintained its guidance for capital spending of $25 billion-$30 billion for the year. Based on its current cash flow, that should result in significant free cash flow for the year. It used most of that cash to pay its dividend and reduce its debt load by $1.4 billion. At the end of the quarter, its net gearing was 24.7%, still above management's target range of 20%.

What management had to say

Since it bought BG Group back in 2015, Shell has intended to buy back a significant number of shares to offset shareholder dilution from the acquisition. Even though it hasn't started buying back shares, CEO Ben Van Beurden mentioned that it is still part of the company's plan over the next two years (bolded emphasis my own). 

We have a strong financial framework. Our commitment to capital discipline is unchanged, we are making good progress with our $30 billion divestment programme and our outlook for free cash flow – which covered our cash dividend and interest this quarter and over the last year – is consistent with our intent to buy back at least $25 billion of our shares over the period 2018-2020.

RDS.B Chart

RDS.B data by YCharts.

Lots of progress, but the next hurdle is big

As great as Shell's results have been, this isn't going to be an easy task. It has to generate enough cash to lower its debt gearing range to that desired 20% range, pay dividends for the next couple of years, plus $25 billion for stock repurchases. That is still going to have to take a significant improvement from these most recent results to get there.

CFO Jessica Uhl has said many times that it won't initiate buybacks until it has met its target gearing range, but it should be able to get there in the next couple of quarters as it pays down a lot of near-term debt (about $14 billion). Once that gets taken off the books, it should put Shell on a path where it can start to put that cash to work buying back shares.

For investors, though, this is another good report in what has been a string of impressive earnings reports for Shell. The company looks extremely well positioned to ride this wave of higher oil prices in the short term and reap the long-term trends of LNG that should reward shareholders well.