On Thursday, Royal Dutch Shell ((RDS.A), (RDS.B)) confirmed an abysmal earnings pre-announcement announced back on January 17. Year-over-year fourth quarter net income was down 71%; full year net was down 39%. Operating Cash Flow was down 12%, and the new CEO scrapped an ambitious 4-year Plan to improve OCF by 50% versus the prior 4-year period.
An unfavorable ruling by the Ninth Circuit Court convinced the company to pull the plug on Arctic exploration activities in 2014, perhaps leading to hundreds of millions of dollars lost and/or written down.
The security situation in Nigeria has worsened, and the expectation is that Shell will retrace much of its presence in that region.
Recognizing its big bet on North American natural gas has soured, Royal Dutch has sold assets, will sell more, and future impairment charges may be necessary.
Full year oil products and chemical sales volumes were down.
And Shell had to borrow funds to pay the 2013 dividend.
The stock rose on the news, up 1.21%. The RDS "A" shares improved slightly more than the overall market. Indeed, the stock has been rising since settling below $63 on October 9. The ADRs have increased some 12%, nearly doubling the corresponding S&P 500 advance over the same period.
What's Going on Out There?
I see 3 major story lines:
- New CEO Ben van Beurden plans to change a few things.
Mr. van Beurden decided quickly it was time to alter course. In his first Wall Street address since assuming the CEO role, he immediately announced several significant changes. At the top of the list is a renewed emphasis upon capital efficiency and associated restructuring. He believes Shell has been spending too much on too many growth projects.
In addition, shaving the asset base was called to task; to the tune of ~$15 billion over the next two years. This amounts to about 4% of the Group's total assets. Dud investments from Nigeria to the United States had resulted in return-on-capital-employed (ROIC) falling to 7.9% from 13.6% a year earlier, putting Shell at the bottom of the Super Major pack.
- A Wall Street honeymoon is in order.
CEO van Beurden was applauded by Wall Street for quickly going after several major Shell themes that had been bugging them. Certainly, a "grace period" is warranted for a potential silver knight, right?
First, the entire Alaska / Arctic exploration effort has been under a great deal of pressure for some time. The Ninth Circuit provided the final nail in the coffin so RDS management could kill the deal. Analysts liked it.
Second, many commentators long recognized that Shell's efforts to make hay in the North American shale plays was a loser. My view is that there are too many smaller, faster, cheaper E&P companies out there. Internal processes at Shell make it difficult for the company to compete with aggressive drillers like EOG Resources (EOG) and Continental Resources (CLR). It's a bit of wildcatter territory out there, and Shell is no wildcatter. Royal Dutch got to the party a little late: the smaller guys sopped up some of the best land and buttressed it with operational flexibility. EOG and Continental are both racking up record revenues and cash flow.
Third, van Beurden spoke the today's oil patch magic words without stuttering: "capital efficiency." Wall Street had grumbled about the enormous amounts of capital Shell had previously committed to spend. In 2013, capital expenditures totaled $46 billion. The new CEO stated that the number would tumble by some 20% in 2014, further offset by asset divestitures. He got additional marks for acknowledging that Shell was "losing some operational momentum," and needs to "sharpen up in a number of areas."
Putting an exclamation point on the address, van Beurden surprised me a bit by ditching the 4-year "Run for Cash" Plan heralded by previous CEO Peter Voser. I thought van Beurden would take a more "go slow" approach. I was wrong. Here's a clip from his January 30, 2014 prepared remarks:
With the changing operational landscape and the streamlining of Shell's portfolio, the company will no longer be updating against previous cash flow and net spending targets. "I want Shell to be measured on our competitive performance."
Out with the old, and in with the new.
- Dividend hikes always put folks in a good humor.
Despite the distress, Shell announced it expects to bump the first quarter dividend by 2 cents, or 4.4%. Based upon a closing price of $71.35, the new annualized yield will be a very healthy 5.3%. It underscored management's commitment to improve business and execute better pull-through operational delivery. In 2013, Shell experienced a free-cash-flow deficit of $3.5 billion, requiring borrowing to fund the payout. Continued strong operating cash flow, reduced capex, and asset sales will put Royal Dutch back in the black for 2014.
One Man's Take on the Events
I found myself impressed by the strength of Mr. van Beurden's clarity of vision. Historically, Shell is a very conservative company; some may argue too conservative. It will be interesting to watch the magnitude and speed of change, as well as the bottom line results.
I had no problem with the tenants of the previous 4-year Plan. Running for cash, business growth, keeping a strong balance sheet and tying the results to the dividend sounded pretty good to me. Shell has long been saddled with a "show me, don't tell me," label and the Plan appeared to address some of that. Prior management had stated their objective to boost share prices.
The new direction is likewise acceptable. Capital efficiency, trimming weak assets, selective restructuring, strong cash generation, operational excellence, and evaluating competitive performance versus peers is fine. Unquestionably, Wall Street liked both the message and the messenger: at least for today.
However, there's a word of caution. Honeymoons don't last forever. Royal Dutch Shell holds outstanding assets, is carefully managed, and is blessed with a highly talented workforce; yet has been criticized for never quite reaching full potential. At times, senior management's emphasis and strategies have been altered or scrapped before reaching the summit.
Many plans can work; the best businesses pick one plan and execute it flawlessly.
Despite the ample dividend, I contend this is a major reason that over the past 10 years, RDS shares have lagged its Super Major counterparts Exxon Mobil (XOM) and Chevron Corp. (CVX). To be fair, Shell has bested returns versus its two EU Super Major counterparts, BP PLC (BP) and Total SA (TOT).
Please do you own careful due diligence before making any investment decision. This article is for information purposes only. Good luck with all your 2014 investments.