When Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) announced its acquisition of BG Group back in 2015, management said that it would be divesting about $30 billion worth of assets, and that the proceeds, combined with its growing free cash flow, would be used to buy back stock to offset the shares it issued to complete the deal. After a couple quarters in a row of robust free-cash-flow results, many investors have been wondering when it will actually get around to putting that cash toward repurchasing stock.

The answer to that, apparently, is now: Management announced in conjunction with its second-quarter earnings report Thursday morning that it intends to buy back a whopping $25 billion in stock between now and 2020. Let's dig into the numbers to see why management sees this as the right time to fulfill its earlier promise.

Loading an LNG vessel

Image source: Getty Images

By the numbers

Metric Q2 2018 Q1 2018 Q2 2017
Revenue $99.3 billion $89.2 billion $72.7 billion
Net income $6.02 billion $5.90 billion $1.54 billion
Earnings per ADS $1.44 $1.40 $0.38
Operating cash flow $9.50 billion $9.42 billion $11.28 billion

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

This was the second consecutive quarter with much stronger earnings results. As CEO Ben Van Buerden mentioned in the press release, the company generated its highest cash flow, net of working capital changes, since Q1 2014. What stands out here is how that statement dovetails with the overall cash flow results from this time last year, but it highlights how much a company the size of Shell can see its cash flow change because of working capital movements. There was a $6 billion increase in working capital and other balance sheet adjustments compared to this time last year that tamped down on reported cash flow.

The gem of the company's earnings report is its integrated gas segment, where earnings nearly tripled compared to this time last year. While the volume of liquefied natural gas sold was up 12% compared to the prior quarter, earnings in this segment were driven in large part by high LNG prices propelled by strong demand from China. Perhaps the more surprising result from the quarter was the decline in earnings from Shell's upstream production business. Though prices were up significantly, production was down due to prior asset sales and higher than usual amounts of field maintenance.

RDS earnings by business segment for Q2 2017, Q1 2018, and Q2 2018. Shows significant uptick for integrated gas.

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

The highlights

  • Production for the quarter was 3.44 million barrels of oil equivalent per day, down about 50,000 barrels year over year. All of those declines came from its upstream oil and gas production side, as production dedicated to its integrated gas segment was up 16%.
  • The company's Kaikias offshore project in the Gulf of Mexico started to produce. Its first phase will deliver 40,000 barrels of oil per day.
  • Shell also announced another large oil discovery in the Gulf of Mexico. The Dover well hit 800 feet of oil-bearing rock, and is located relatively close to several other discoveries within its leaseholds. 
  • The company's LNG Canada project moved one step closer to reality after RDS signed an agreement to sell a 25% equity stake in it to Malaysian state-owned energy company Petronas. No timetable has been given on when management will make a final investment decision, but we can probably expect one by the end of the decade.
  • Management also signed on for two new exploration blocks off the coast of Mauritania, which has been a hot region lately as all five of the big oil companies have started exploration there. Combined, the two blocks are 23,600 square kilometers (about the size of New Jersey).

What management had to say

Here's van Beurden's press release statement explaining why his management team thinks it's the right time to start this buyback program.

Today we are taking another important step toward the delivery of our world-class investment case, with the launch of a $25 billion share buyback programme.

This move complements the progress we have made since the completion of the BG acquisition in 2016, to reshape our portfolio through a $30 billion divestment programme and new projects, to reduce net debt, and to turn off the scrip dividend.

Our financial framework remains unchanged. Our free cash flow outlook and the progress we have made to strengthen our balance sheet give us the confidence to start our share buyback programme.

RDS.B Chart

RDS.B data by YCharts

Timing seems right

Ever since the BG deal and the subsequent plan to reduce debt and buy back stock, the company has delivered quite well on its efforts to improve per unit costs and shed assets that didn't make as much sense in the oil and gas production companies' combined portfolio. It has paid down about $13 billion in debt over the past year, and now has a gearing (net debt to capital) of 23.6%. That's a little higher than some of its peers, but it's a reasonable number for a company of its size.

Some on Wall Street are critical of the choice to route capital into a share buyback program right now. They think the company should instead be looking to increase spending to grow production. One thing investors should keep in mind, though, is that management has said the planned stock repurchases are contingent on oil prices and its balance sheet, so the $25 billion figure isn't set in stone. If other opportunities to better deploy those funds arise between now and the end of the decade, it's entirely possible that management could change course. 

What really matters here is that Shell is looking to increase shareholder value in what it views as the best way available to it right now. With oil prices at a comfortable level, and a business that is churning out cash, its shares look rather attractive.

Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.