I firmly believe that Royal Dutch Shell’s (RDS.A) (RDS.B) stock price may come under further pressure once its 3Q19 results are announced on October 31, 2019, and I have plenty of evidence to support this statement. Shell released a preliminary report for the third quarter on Monday, September 30th, and there were some very interesting insights that were up for grabs. Before analyzing these insights, it is important to take a quick look at the company’s 2Q19 financial performance.
Whenever a reputed company that performs consistently well reports weaker than expected financial numbers, markets tend to get disappointed. This is exactly what happened with Shell in 2Q19. Shell’s 2Q19 profits went down by almost 25%, which was far below the market’s expectation of $4.9 billion. In fact, 2Q19 was Shell’s worst financial performance since the 2016 oil price slump. Low oil prices, combined with weaker gas demand and lower refining profits played a major role in Shell’s disappointing performance in 2Q19. In fact, the biggest setback for Shell in the second quarter was its Integrated Gas division which performed badly because of a weaker gas market. It wouldn’t be wrong to say that Shell’s biggest strength (its Integrated Gas division) became its biggest weakness in 2Q19.
According to the latest update, Shell’s upstream production went down by 2.7% on a YoY basis in 3Q19. This is not a good development, as Shell’s upstream earnings had already taken a big hit in 2Q19 because of low oil prices and declining quarterly production. Shell is estimating its 3Q19 upstream production to be in the range of 2.6 to 2.65 million barrels per day compared to 2.67 million barrels per day in 3Q18. Though the difference is not too big, I cannot see any upside and consider this to be a weak upstream performance.
Shell’s downstream earnings had fallen to 1.07 billion in 2Q19, but the latest update indicates that earnings in 3Q19 can be slightly better than the previous quarter (if chemical cracker and intermediate margins remain unchanged compared to 2Q19). As per the report, oil product sales are expected to increase and be in the range of 6.7 to 7.35 million barrels per day, while chemical sales may decline and will be in the range of 3.9 to 4 million tonnes. Interesting!
When I look at the most crucial part of the latest performance update, my confidence in Shell's long-term potential increases even further. Shell’s LNG liquefaction volumes are expected to be in the range of 9 to 9.3 million tonnes, which translates into an impressive growth of around 10%. Investors must note that Shell’s liquefaction volumes had declined (on a quarterly basis) in 2Q19 at 8.66 million tonnes. Besides, Shell’s integrated gas production is expected to increase on a YoY basis and be in the range of 930,000 to 960,000 barrels per day. Although these numbers look promising, what concerns me more is the global gas market (and gas demand) which continues to remain weak.
In my earlier article on Shell (which I wrote in August 2019), I had maintained a ‘neutral’ rating for its stock. I had stated that if gas demand continues to remain weak in 3Q19, the stock may fall in the near future. Shell was trading at $58.78 when my earlier article was published. The stock is currently trading at $58.39. If I summarize based on the latest performance update, Shell’s Upstream division may continue to struggle in 3Q19 because of an unexpected dip in its upstream production, its Downstream division may report marginally better numbers (compared to 2Q19) while its Integrated Gas division may report similar numbers (compared to 2Q19) due to weaker gas markets.
Plus, there have been some additional write-offs (related to unsuccessful exploration drilling) in 3Q19 in the range of $250 to $300 million when compared to the previous quarter. The cumulative effect of the above-stated factors may put downward pressure on the stock price starting from November this year. However, I still maintain a neutral rating for Shell for the short term and accept the fact that production numbers may change once the quarterly results are announced on October 31st, 2019.
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