For the second quarter in a row, Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) stared down what was supposed to be a weaker quarter for oil and gas companies and posted impressive results. Even though oil and gas prices were down slightly compared to the prior quarter and refining margins in North America were markedly weak for the quarter, the company was able to produce expectation-smashing results and continued its path of generating loads of cash and buying back generous amounts of stock.
However, buying back stock can only do so much, especially for an oil and gas company that requires incredible amounts of invested capital to maintain the business. So let's take a look at Shell's most recent earnings report and its plans for the next few years to get a read on how the company plans to grow both the business and shareholder returns.
By the numbers
|Metric||Q1 2019||Q4 2018||Q1 2018|
|Revenue||$85.66 billion||$104.6 billion||$91.11 billion|
|Net income||$6.00 billion||$5.59 billion||$5.90 billion|
|Earnings per ADS||$1.48||$1.36||$1.42|
|Operating cash flow||$8.63 billion||$22.0 billion||$9.47 billion|
One of the remarkable aspects of Shell's most recent earnings results was the fact that its downstream segments -- oil products and chemicals -- performed reasonably well. Other oil majors this past quarter noted that refining margins were some of the weakest they had experienced over the past decade. Fortunately for Shell, though, much of its refining business is outside North America and it was thus less exposed to that particular market weakness.
Cash generation has been one of management's primary objectives over the past few years, so this past quarter's $8.6 billion in cash from operations looks a little discouraging when compared with the prior quarter and this time last year. Management noted in the earnings press release that it had a significant buildup for working capital in the quarter, and absent that build, operational cash flow was around $12 billion. These cash buildups and drawdowns are incredibly common, so no one should overreact to a single quarter's cash results.
- Total production for the quarter averaged 3.75 million barrels of oil equivalent per day. That's more or less flat with the prior quarter and is a product of some new projects offsetting natural decline and some divestments.
- The company announced two more significant divestments: its interest in the Saudi Arabia Refining Limited's joint venture in Jubail, Saudi Arabia, and its nonworking interest in the Caesar-Tonga offshore project in the Gulf of Mexico to Delek. The two asset sales total $1.59 billion.
- Shell announced another significant oil discovery at its Blacktip prospect in the Gulf of Mexico. The discovery is close enough to existing assets in the region that Shell should be able to access it without significant infrastructure investments.
- The global oil company also upped its game in the renewable energy business by making three acquisitions in the quarter: German energy storage company sonnen, virtual power plant manager Limejump, and electric-vehicle charging start-up Greenlots.
- On paper, the company's gearing ratio, using net debt to capital, increased to 26.5%. This increase wasn't because the company took on more debt, but because it adopted new accounting standards known as IFRS 16. The change to this accounting standard resulted in a 4.6% increase to its reported gearing ratio.
- On the day that management announced earnings, it also announced that the board had approved another tranche of share repurchases. The company will now buy back $2.75 billion in shares before July 29. This tranche of buybacks is part of management's plan to repurchase $25 billion in shares by the end of 2020.
What management had to say
The talk of the town in the oil and gas world right now is the bidding war between Chevron and Occidental Petroleum to acquire Anadarko Petroleum. That deal has led to everyone on Wall Street looking at what large companies like Shell have done in places like the Permian Basin and whether more acquisitions are in store. When asked about Shell's position in the Permian Basin and its appetite for acquisitions, CFO Jessica Uhl highlighted the company's performance in the prolific shale basin and explained why it isn't in a hurry to make acquisitions for that business:
In terms of the shales business and appetite for [mergers and acquisitions], I'll start off by just saying we're very pleased with the performance of our shales business and the portfolio that we have today. We're generating some 370,000 barrels a day from that business. That's a 13% increase year on year. So we've been growing that business steadily. If you look at just the Permian position that we have, and we think we've got some of the best acreage in the Permian currently. Our production is up some 70%-plus over the year. And we see significant growth opportunity with our existing position in the Permian, but also in Canada and in Argentina as well. And last year, we took some investment decisions to support growth across all of those assets.
So we have growth capacity in our existing position. And in that sense, we're not desperate. We don't -- we don't need to find new shale exposure for that business, nor for supporting Shell's wider cash flow growth going into the 2020s. That being said, we've been clear that we like the business. We've transformed the way we run that business and we now consider ourselves to be one of the top operators certainly in the Permian, and we've got benchmark data to prove that from an operating-cost perspective and from a well-cost perspective. So we have confidence in our capability in the space and our ability to create value. So that gives us more interest and appetite to get further exposure in the shales business.
You can read a full transcript of Shell's conference call here.
Gearing up for Shell's next wave of investments
If there is one knock on Shell's most recent earnings results and business strategy, it's that the company appears more intent on extracting value out of the business with operational improvements and asset sales than growing the business. This approach has worked out well thus far as the company is generating gobs of cash and its return on capital employed has increased significantly over the past couple of years. The one thing that felt less certain was the company's direction once it completed these asset sales and share buybacks.
Fortunately, the company helped to alleviate those concerns by publishing its entire portfolio of projects, both under construction and being considered for final investment decision. As it stands today, the company has production capacity of about 650,000 barrels of oil equivalent per day and 5.6 million tons per year of LNG, as well as 1.5 million tons of new chemical production facilities. Beyond that, it's assessing a slew of assets across all of its business segments.
Of course, not all of those proposed projects will come to fruition, but the list gives investors some sense of how Shell plans to grow over the next decade. The company is getting more out of its existing portfolio and has loads of cash to invest, which gives a greater sense of security that it will be able to produce strong returns for investors well into the future.