In my April 13 earnings preview for Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B), I wrote that, according to my calculations, Shell's upstream earnings which were $493 million in the fourth quarter of 2015 could turn into a loss in the first quarter of 2016. Moreover, I assumed higher downstream earnings in the first quarter than the $1.524 billion obtained in the previous quarter, and that the increase in the downstream earnings will be lower than the decrease in the upstream earnings, and that really is what has happened.
On May 04, Shell reported its first quarter 2016 unaudited financial results. First quarter 2016 earnings attributable to shareholders excluding identified items were $1.6 billion compared with $3.7 billion for the first quarter 2015, a decrease of 58%. Earnings of $0.44 per share were higher by a $0.17 (65%) than the adjusted EPS estimates. Revenues of $48,554 million compared to $65,706 in the same quarter a year ago, a decline of 26%, were below the consensus estimate of $53,165 million. The decline year-over-year in earnings and revenues were due to a 37% lower oil price, a 31% lower U.S. gas price and lower refining margins.
Source: Quarterly Results Announcement
In the report, Royal Dutch Shell Chief Executive Officer Ben van Beurden commented:
Shell's integrated activities differentiate us, with our Downstream and Integrated Gas businesses delivering strong results and underpinning our financial performance despite continued low oil and gas prices. We continue to reduce our spending levels, to capture cost opportunities and manage the financial framework in today's lower oil price environment. The combination with BG is off to a strong start, as a result of detailed forward planning before the completion of the transaction. This will likely result in accelerated delivery of the synergies from the acquisition, and at a lower cost than we originally set out. Putting all of this together, capital investment in 2016 is clearly trending toward $30 billion, compared to previous guidance of $33 billion, and some 36% lower than combined Shell and BG investment in 2014. Annual operating expenses excluding identified items are trending towards a run rate of $40 billion compared with 2014 combined spend of around $53 billion. In practice, we expect to absorb BG's capital investment and operating expenses during 2016, with no net increase overall, compared with Shell stand alone in 2015.
During the first quarter, Shell completed the acquisition of BG for a purchase consideration of $54,034 million. This includes cash of $19,036 million, and the fair value ($34,050 million) of 1,523.8 million shares issued in exchange for all BG shares. Following completion of the acquisition on February 15, 2016, BG was consolidated within Shell's results. For practical purposes, this includes February and March 2016, as the impact for the first half of February is deemed immaterial. The consolidation of BG resulted in an increase to first quarter 2016 cash flow from operating activities of $0.8 billion and an increase to CCS earnings attributable to shareholders excluding identified items of $0.2 billion.
Oil prices have shown a significant rebound in the last four months. As such, we can expect much better results for Shell's upstream operations in the forward quarters. The last price of Brent crude oil $47.83 per barrel is already up 55% from its 12-year low on January 20, of $30.84, while WTI crude oil last price of $46.21 per barrel is up 45.5% from its January 20 low of $31.77.
According to OilPrice.com, market fundamentals continue to suggest that the combination of robust demand and weak supply growth will move global oil markets closer into balance by the end of the year. Oil prices held steady this week despite a rash of news that emerged. Canada lost more than 1 million barrels per day of oil production, but several oil sands companies are working with the Alberta government to bring at least some production back online as quick as possible.
Also on May 05, Nigerian militants attacked a platform operated by Chevron (NYSE:CVX) in the Niger Delta. The facility is currently shut-in and according to Chevron, they are assessing the situation and have deployed resources to respond to a resulting spill. Although the volume of oil disrupted in Nigeria is smaller than in Canada, the problems facing oil producers in Nigeria are much more severe. The Forcados export terminal remains offline, blocking 250,000 barrels per day of exports. Altogether, Nigeria has roughly 500,000 barrels per day offline, taking production down to more than twenty-year lows. Shell also declared force majeure for Bonny Light because of an explosion at a pipeline, shutting down the conduit. The outage could affect 200,000 barrels per day.
Moreover, EIA figures look bullish. Oil stocks fell by 4 million barrels last week, the first drawdown in more than a month. Weekly production numbers dropped again, down another 23,000 barrels per day. U.S. oil production now stands at 8.8 million barrels per day, down about 900,000 barrels per day from the April 2015 peak. The weekly declines have been remarkably consistent, with drop offs only varying in degree. By all accounts, the losses will continue through the rest of the year.
According to EIA, in response to continued low oil prices, onshore crude oil production in the Lower 48 states is expected to decline from an average of 7.41 million barrels per day in 2015 to 6.46 million in 2016 and 5.76 million barrels per day in 2017. Increased production from the federal Gulf of Mexico is not enough to offset those declines, with total projected U.S. production falling from 9.43 million barrels per day in 2015 to 8.04 million barrels per day in 2017. The sharp drop in oil prices since the fourth quarter of 2014 has had a significant effect on drilling in the United States. The number of active onshore drilling rigs in the Lower 48 states fell 78% (from 1,876 to 412) between the weeks ending on October 31, 2014, and April 15, 2016, according to data from Baker Hughes (NYSE:BHI). The decline in active rigs and well completions is projected to result in month-over-month onshore oil production declines of 120,000 barrels per day through September 2016.
Brent Crude Oil, July 2016 Leading Contract With 50 Day Moving Average
WTI Crude Oil, June 2016 Leading Contract With 50 Day Moving Average
Charts: TradeStation Group, Inc.
Shell has confirmed its intention to pay a dividend of at least $1.88 per A share in 2016, currently yielding 7.57% (each ADS represents two ordinary shares, two A Shares in the case of RDS.A). The current yield is historically high, which indicates that the stock is undervalued, according to some dividend assessment theories. In my view, this high dividend pay is sustainable. The company has a long record of continued raising its dividend. The annual rate of dividend growth over the past three years was at 3.8%, over the past five years was at 2.3%, and over the last ten years was at 7.8%. Even during the global economic crisis of the years 2008-2009, the company continued to raise its dividend. As such, it is hard to believe that Shell would break that many years tradition. In addition, the recently completed BG deal is providing synergies in deepwater, LNG and upstream assets. The company sees cost synergies of $2.5 billion per year by 2018, and expects to generate cash from operations in the range of $55 billion - $70 billion by 2020; this compares with 2014 cash from operations of $45 billion.
Since the beginning of the year, RDS.A's stock is up 8.4% while the S&P 500 Index has increased 0.1%, and the NASDAQ Composite Index has lost 5.8%. However, since the beginning of 2012, RDS.A's stock has lost 32.1%. In this period, the S&P 500 Index has increased 62.7%, and the Nasdaq Composite Index has risen 81.1%.
RDS.A Daily Chart
RDS.A Weekly Chart
Charts: TradeStation Group, Inc.
RDS.A stock is trading below book value; price to book is at 0.91, and its price to sales ratio is very low at 0.75. The forward P/E is very low at 11.11, and the Enterprise Value/EBITDA ratio is also low at 12.28.
Shell delivered first quarter 2016 results which beat EPS expectations by a significant margin of $0.17 (65%). According to Shell, the combination with BG is off to a strong start. This will likely result in accelerated delivery of the synergies from the acquisition, and at a lower cost than the company initially set out. Oil prices have shown a significant rebound in the last four months. As such, we can expect much better results for Shell's upstream operations in the forward quarters. According to OilPrice.com, market fundamentals continue to suggest that the combination of robust demand and weak supply growth will move global oil markets closer into balance by the end of the year. Investing in a super-major integrated oil & gas company like Royal Dutch Shell will give investors a significant price appreciation when oil prices recover along very generous dividend yielding about 7.6%.
Disclosure: I am/we are long RDS.A.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.