How sentiment and perspective make a difference on Wall Street.
Let's take a look at the Royal Dutch Shell's (RDS.A) earnings release and conference call held on Thursday.
Shell senior management touted fulfilling the first year of their four-year financial growth plan. CEO Peter Voser outlined the plan objectives, its results, then capped it off by declaring the expectation of a five percent increase in the third quarter dividend.
Here's a summary slide from the conference call presentation:
Wall Street promptly threw up all over it, dissing the numbers and pounding the shares down about three percent. Shares are down again today.
Here's my take on the call, the results, and why Wall Street is fretting.
Shell management had previously announced an ambitious, 2012-to-2015 financial growth plan. There are four cornerstones:
- Improve operating cash flows between 30 and 50 percent versus the previous four-year period; the target is OCF of $175 to $200 billion over the period
- Capital investment of $120 to $130 billion over the period; emphasizing the following three lines of business:
1. Integrated natural gas opportunities
2. Deepwater production
3. "Tight" hydrocarbon and shale resource plays
- Maintain a strong balance sheet;
- Link the cash dividend to the results
The goals and objectives are premised upon roughly $80 to $100/bbl oil prices. If the price stays towards the upper end of the range, Shell management states the spending and results will follow along their upper target ranges, too.
Here's a slide from the presentation outlining the Plan:
First Year Results
On the conference call, Shell management highlighted the first-year success of the plan and results. Indeed, Voser and CFO Simon Henry spent much more time on the long view than current quarter results.
The execs offered the following:
- 2012 operating cash flows of $46 billion are up nearly 70 percent since 2010; I generated a table below that offers up some of the numbers.
Operating Cash ($B)
Free Cash Flow ($B)
FCF / Share
Dividend / Share
- Operating cash flows increased (and will continue to increase) faster than either production or earnings
- Production, manufacturing and SG&A expenses have been held generally flat since 2008, demonstrating good expense management
- Gearing (a British term for financial leverage) decreased in 2012, and sits at the low end of the Plan range; thereby demonstrating solid balance sheet management
- Shell is beating their peers on earnings and cash flow growth. Execs made the point on the conference call with the following comparison chart:
- An array of strong Upstream projects that are have been competitively vetted within the company and are ready-to-go. CEO Peter Voser reinforced this point in the conference call:
Our drive to increase our options set means that Shell today is capital constrained rather than opportunity constrained. I think this is a rather different position than many other sectors in the market today, including our competitors. Strong capital rationing means we can prioritize the most attractive opportunities and re-scope or exit from other priorities or positions.
- A board and management team that is committed to increasing shareholder value via the dividend. The dividend is planned to increase from $3.44 to $3.60 this year.
Here's a remarkable exchange from the conference call Q/A session of the call that leaves little room for doubt as to intent:
Simon Henry, Chief Financial Officer and Executive Director
Dividend is linked to the earnings and the cash flow generation and should grow in line with that. So it's not constrained by the capital investment, it's the other way around, if anything. The balance sheet may play into -- it could come into play. As in practice, it did back in 2009. If in fact, ongoing cash flow at the environment that we find ourselves in, it doesn't generate investment to cover both organic and the dividend. So it is a ability to afford sustainable increases that we look at first. If you take the free cash flows that we're projecting in the environment we are today, it's not really an issue, the dividend will be financeable.
Wall Street Analyst
So when you look at the cash available for the dividend, it comes after the capital spend. You don't...
Simon Henry - Chief Financial Officer and Executive Director
It comes before the capital spend.
Peter R. Voser - Chief Executive Officer and Executive Director
Wall Street Analyst
Oh, that was my question so it's...
Peter R. Voser - Chief Executive Officer and Executive Director
I don't think it could get much clearer than that, huh?
Wall Street is Unimpressed
Despite the bullish news from Shell management, Wall Street was less than enthralled with the stories. After the earnings report, several brokerage houses downgraded the stock. Here's my take on what they heard:
- While the operating cash flow was good, the company missed Street EPS targets, big-time. Shell management explained the current performance was hampered by the 2012 drop in North American natural gas prices and problems encountered in their leading-edge arctic exploration business. No dice. The Street is about short-term results. RDS missed earnings expectations by a significant margin. No one seemed to care about the operating cash figures.
- Shell's three-year Reserve Replacement Ratio (RRR) was only 85 percent; and the 2012 figure was a dismal 44 percent. Notably, reserve bookings were severely reduced last year by U.S. Securities and Exchange Commission accounting rules that required it to cut its estimates of its gas resources in America to reflect low prices. The company's actual reported production was essentially flat in 2012, at 3.2 million boe (barrels oil equivalent) a day. Shell management stated that 2013 production will be up slightly, and ramp up to over 4 million boe a day by 2017. It fell upon deaf ears.
- Shell is spending too much capital and taking undue risk. Analysts fretted that Shell will find itself in a position whereas it cannot control costs. CEO Voser explained that in 2013, the company will spend about $33 billion capex, of which approximately $18 billion will go towards the development of new projects, and about $12 billion in mature businesses. This is all within the four-year plan. Wall Street didn't credit the Plan, it worried about the cost. Peter Voser's comments on the call were notwithstanding:
Our business strategy requires very significant levels of capital investment. We have not made any secrets of this. There should be no surprises. We're saying exactly the same things about investment today that we said 1 year ago. This is designed to grow earnings and cash flow through the business cycle. We are on track to deliver that $175 billion to $200 billion of cash flow for 2012 through '15.
- The expected 2013 dividend increase isn't big enough, nor will it have much room to range higher over time. This isn't aligned with the Plan premises, nor management's rhetoric, but that didn't appear to change some analysts' view of the situation.
My Take on the Action
I believe there were two major disconnects on the call. The first is situational, and the second is Shell-centric.
Wall Street Thinks Short-Term, Shell is Talking Long-Term
Street analysts largely see the world through short-term, three-month quarterly windows. On this count, Shell did not meet expectations. Period, new paragraph.
Wall Street offered Shell no free pass, and decided to pan the whole earnings report. As news of the report and conference call spread, one brokerage fed off the other. The sound bites from follow-on press releases were subsequently poor, and down goes the ship.
On the other hand, Shell management emphasized a multi-year plan, its opportunities, and results within that context. Shell execs talked about a big picture.
The audience heard a barrel of excuses about disappointing current EPS results.
Shell Management Has Something to Prove
Over the years, mammoth Royal Dutch Shell has been a successful enterprise by most measures. However, the investment community has pinned a "show me, don't tell me" sticker on the company. No free passes.
There is some validity to why this has happened.
In past years, expense management, at times, has been mediocre. Project capex has overrun. Certain business plan execution and results have been weak. Shell senior management, though improving, compounds matters by not having a Street reputation for "telling a good story."
Currently, Shell's spotty experiences in the arctic have received headline media attention, and this has resurfaced concerns about execution and results. The move to be the world leader in the integrated natural gas business while North American gas prices concurrently tanked has Street antennae up. The fact that Shell is involved with tight oil and gas activities in 13 countries, not just the U.S., should be major news, but it's relegated to a secondary storyline. Poor RRR numbers were looked upon within the context of mis-managed execution, not S.E.C. rule changes.
I believe Shell is a fine, long-term investment. Investors may be better served by watching RDS corporate results versus management's multi-year plan metrics/premises versus quarterly Wall Street expectations. The Shell Plan has been well laid-out. It will not be difficult for an investor to gauge the results.
In general, I seek stocks of companies in which management has made a commitment to build long-term shareholder value through sound investment and increasing cash dividends. Royal Dutch Shell stock fits that profile. Shell's management team has demonstrated their commitment to returning cash to investors by the specifics of the four-year plan: running for cash and raising the dividend. On the call yesterday, they re-affirmed these priorities in conjunction with the remainder of the 2012-15 Plan.
I'd give them a chance to execute upon it.
Do your own research, follow the metrics, and make informed investment decisions. Good luck with all your 2013 investments.
Disclosure: I am long RDS.A.