Royal Dutch Shell: Key Takeaways From The Fourth Quarter 2018 Results

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About: Royal Dutch Shell plc (RDS.A), RDS.B
by: Fun Trading
Summary

Royal Dutch Shell has reported revenues and other income for the fourth quarter 2018 of $104.63 billion, up 15.8% year over year and up 3% sequentially establishing a new revenues record.

Upstream production was 3,788 K Boep/d this quarter, up nearly 1% compared to a year ago and up 5.3% sequentially.

This oil company is amongst a few essential companies that will support your financial stability through the inescapable good and bad times of this volatile market.

Royal Dutch Shell products in Torzhok, Russia.

Photo: Royal Dutch Shell products in Torzhok, Russia By Getty Images

Investment Thesis

Royal Dutch Shell (RDS.A) (RDS.B) is the best oil supermajor worldwide, in my opinion, and ought to be one of the first oil stocks to be held as a long-term investment in any savvy investor's portfolio.

The Anglo-Dutch integrated oil company has never missed one single dividend payment since the end of World War II and has been considered a preferred stock for various institutional investors for many decades.

On June 6, 2018, Forbes published its 16th annual Forbes Global 2000 list which includes publicly-traded companies from 60 countries. Royal Dutch Shell is the first oil company in the list, at the 11th place, surpassing Exxon Mobil (XOM) which is at the 13th place.

This oil company is amongst a few essential companies that will support your financial stability through the inescapable good and bad times of this volatile market. The only question is to choose the best investing strategy that will maximize your gain.

However, as I have said in my preceding articles about Shell, I firmly believe that it is always vital to trade a portion of your long-term position to profit plainly from the inherent instability of the market. This strategy often creates a tie between investing and real financial success.

Royal Dutch Shell's fourth quarter results showed tremendous progress again as Jessica Uhl, the CFO, said in the last conference call:

In Q4 2018 we delivered against each of these priorities. We had another strong quarter. Cash flow from operations, excluding working capital movements, was $12.9 billion in the quarter. This was at an average Brent price of $69 per barrel.

Which stock should I choose RDS.A or RDS.B?

According to an article that I recommend to read published by Forbes on September 30, 2018:

In Shell's case, the company's 'A' shares (LON:RDSA) are listed on the AEX/Euronext in the Netherlands, and the 'B' shares (LON:RDSB) are listed on the London Stock Exchange in the UK...

As per the norm, both 'A' and 'B' share have same voting rights, stake-holding level and dividends that you'd come to expect. But for U.K. and global investors in general, excluding U.S. investors, it would make better sense to acquire 'B' shares, as 'A' shares are tied to the Dutch tax system that sees dividends paid out to non-European Union (E.U.) residents minus a withholding tax of 15%.

On the contrary, London-listed 'B' shares have no withholding tax applied to the dividend payout thereby putting the full dividend amount (by shares held) into the holder's coffers.

Royal Dutch Shell - Financial Table 4Q'18, the raw numbers.

Royal Dutch Shell 3Q'16 4Q'16 1Q'17 2Q'17 3Q'17 4Q'17 1Q'18 2Q'18 3Q'18 4Q'18
Total revenues $B 61.86 64.77 71.80 72.13 75.83 85.42 89.23 96.77 100.15 102.23
Total Revenues and other income $B 62.94 67.09 73.31 72.70 77.73 88.12 91.11 99.27 101.55 104.63
Net income in $ Billion 1.38 1.54 3.54 1.55 4.09 3.81 5.90 6.02 5.84 5.59
EBITDA $ Billion 9.00 9.91 12.32 9.66 13.08 13.33 14.64 15.90 15.84 15.12
Profit margin % (0 if loss) 2.2% 2.3% 4.8% 2.1% 5.3% 4.3% 6.6% 6.2% 5.8% 5.3%
EPS diluted in $/share 0.34 0.38 0.86 0.38 0.98 0.92 1.40 1.44 1.40 1.34
Operating cash flow in $ Billion 8.49 9.17 9.51 11.29 7.58 7.28 9.43 9.50 12.09 22.021
Capital expenditures in $ Billion 5.28 5.71 4.31 5.66 5.02 5.86 4.79 5.28 5.80 7.15
Free cash flow in $ Billion 3.21 3.46 5.20 5.63 2.56 1.41 4.64 4.23 6.29 14.87
Total Cash in $ Billion 19.98 19.13 19.60 23.99 20.70 20.31 21.93 19.47 19.11 26.74
Long-term Debt in $ Billion 97.83 77.62 91.63 90.35 88.36 85.67 88.02 80.47 78.38 76.82
Dividend per share in $ 0.94 0.94 0.94 0.94 0.94 0.94 0.94 0.94 0.94 0.94
Shares outstanding (diluted) in Billion 4.05 4.09 4.11 4.15 4.16 4.18 4.19 4.17 4.18 4.15

Sources: Royal Dutch Shell filings and Morningstar.

Trends And Charts: Revenues, Earnings Details, Debt, Free Cash Flow, And Upstream Production

1 - Revenues and other income

Royal Dutch Shell has reported revenues and other income for the fourth quarter 2018 of $104.63 billion, up 15.8% year over year and up 3% sequentially establishing a new revenues record again (please see chart above). The full-year profits surged 36% to $21.4 billion in 2018, which is the company's highest annual earnings since 2014. Below is the chart breaking down the earnings per segment since the 1Q'15.

This quarter saw a weakening of the prices of oil and gas sequentially. Global liquid price of oil was $59.89 compared to $68.21 in 3Q'18. Below are some financial components for 2018 compared to the preceding years.

Source: Shell presentation

2 - Free cash flow (organic FCF not including divestitures)

Free cash flow has increased significantly this quarter compared to the last three precedent quarters of 2018 and reached a whopping $14.87 billion in 4Q'18.

Shell has made $30.03 billion in free cash flow in 2018. Notice that dividend payout is approximately $15.8 billion now. Jessica Uhl, the CFO, said in the last conference call:

Our organic free cash flow for the quarter was $14.3 billion. Organic free cash flow covered the full cash dividend, interest expense, reduced gearing, and funded our buyback programme for all of 2018.

Based on this FCF (not including divestitures), Royal Dutch Shell is passing the FCF test, even with the implementation of a $25 billion buyback shares.

Shell is paying a current yield of 5.8%, which is one of the best returns in the oil sector.

3 - Oil-equivalent production and others

Upstream production was 3,788 K Boep/d this quarter, up nearly 1% compared to a year ago and up 5.3% sequentially. It was a substantial production number this quarter with a decent oil price close to $60 per barrel.

Production increased significantly from 2016 and had reached nearly 100 K Boep/d and is expected to be about 240K Boep/d by 2020.

The company began the start-up of Clair Phase 2 in the North Sea with an expected 120K Bop/d. Also, the three blocks in the Vaca Muerta in Argentina are moving to development and will produce in the mid-2020s.

The company is also investing in new Energies business. Jessica Uhl said in the conference call:

as part of our power portfolio in our New Energies business, we acquired offshore wind leases off the northeast coast of the US. These have the potential, if developed, to provide peak power generation capacity of 4.1 gigawatts, enough power to supply some 1.7 million homes. Shell is well placed to develop these opportunities, combining our offshore capabilities and our wind experience - along with the experience of our partners.

New projects are expected to deliver 150k Bo/d of new output in 2019 which is qualified by Ben Van Beurden as "more than enough" to offset field declines.

4 - Net debt and cash

The net debt dropped to $50.1 billion at the end of December 2018 compared with nearly $65.36 billion a year earlier. Good progress was due primarily to divestments.

Source: Shell presentation - Cash allocation

Net debt represents a notable reduction spread over the last eight quarters (please see the company's graph above). This substantial decrease was possible due to the completion of a $30 billion divestiture program completed in 2018, including revenues from the MLP spin-off called Shell Midstream Partners (SHLX).

Jessica Uhl said on the conference call:

Divestment proceeds, along with growing CFFO, have played a key role in bringing this down. Net debt decreased almost $26 billion since 2016, and around $9 billion since the last quarter. The net debt reduction in Q4 is supported by a large release of working capital linked to the drop in oil prices, as well as reduced inventory levels

Net Debt-to-EBITDA ("TTM") is now 0.81x, which represents the number of years Shell needs to pay off the debt theoretically. It is an excellent ratio that has been going down steadily.

5 - Q1 2019 outlook and 2019.

Source: Shell presentation

Upstream: Shell expects slightly lower production in Q1'19 to around ~3,740K Boep/d.

Conclusion and Technical Analysis

Royal Dutch Shell recent earnings are very impressive with free cash flow reaching a whopping $14.9 billion in 4Q'18 alone. Ben van Beurden, Chief Executive Officer, has accomplished what he promised after acquiring BG Group Plc (OTCQX:BRGYY) in February 2016 for $53 billion.

With such a cash machine in place, the company has lessened investors' doubts about whether Royal Dutch Shell can manage concurrently to reduce its debt load as it did again this quarter. It is a huge task to complete a massive share buyback of $25 billion by the end of 2020, pay one of the world's most substantial cash dividends reaching 5.8% and invest a strong CapEx estimated between $25 billion and $30 billion until 2020.

At least, the company is confident it will deliver it, with oil prices stay at or above $60 per barrel. However, I have my doubts and would like to see the company reduce the share buyback programme significantly.

Jason Gammel at Jefferies LLC wrote:

Dividends and repurchases are delivering a more than 10 percent cash return yield to shareholders, by far the highest in the sector.

A small element of concern is that the company is not replacing what it produced in 2018 and it could be an issue down the road.

The company renewed about 50% of the 1.4 billion barrels of reserves produced and sold in 2018 which is well below the good replacement ratio that should be expected.

This under-investing issue could be due to a one-time-event though, due to the scrapping of the Dutch gas field reserves forced after earthquake risks. Without this special event, the replacement ratio would have been much better and close to 98%.

Technical analysis - short-term and midterm.

RDS.B is forming an ascending triangle pattern with line resistance at $64.75 (I recommend selling about 15% at this level) and line support at around $62 (I recommend buying and accumulating again). The chart above is not indicating the new line support which can be created by the low point in December 2018 and the low point at the end of January 2019.

Generally, traders consider ascending triangle patterns a bullish formation mid-term, but the issue is more complicated when it comes to this Industry because oil prices volatility can turn around this favorable situation quite unexpectedly.

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Disclosure: I am/we are long RDS.B. 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.