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Morningstar | Shell Delivers Underwhelming 2Q Results, but Long-Term Targets Remain Intact

Best Idea Shell’s second-quarter earnings report proved to be somewhat disappointing, as higher oil prices did not translate into the increase in earnings and cash flow the market was expecting despite reporting strong year-over-year increases. Though the results were received negatively by the market, we do not see them as indicative of future potential. Our fair value estimate and no-moat rating remain unchanged, leaving Shell as one of the most undervalued integrateds.

Adjusted earnings for the quarter rose to $4.8 billion from $3.7 billion a year before, a 30% increase driven by a near doubling in integrated gas earnings and more than trebling of upstream earnings. However, both segments reported lower earnings compared with the first quarter despite a 10% increase in oil prices. While a strengthening U.S. dollar during the quarter hurt, a decline in production volumes also contributed to the decline. Integrated gas volumes were 16% higher than the second quarter last year but 2% lower than the first quarter. Upstream volumes were lower by 7% from last year and 13% lower than the first quarter. Those figures, however, include divestitures, which were the primary cause of the year-over-year decline, while seasonality in gas volumes resulted in declines in volumes from the first quarter. Excluding the impact of divestitures, production increased 2% from the second quarter last year. The downstream segment also reported a weak quarter, with earnings falling 34% from the year before, largely due to weakness in the refining and trading segment. Refining margins were only modestly weaker than last year, suggesting the weakness was due to poor trading results. Finally, operating cash flow disappointed as well, falling to $9.5 billion from $11.3 billion last year and was only a modest improvement from the $9.4 billion in the first quarter.

Shell’s operating cash flow continues to be plagued by tax impacts, margin requirements related to hedging in the integrated gas business, and working capital requirements. Working capital movements reduced operating cash flow by $2.1 billion during the quarter while boosting it by $2.5 billion last year.

Shell’s portfolio remains in transition, as evidenced by the large volume of divestitures, and has seen numerous one-off items over the last year affect earnings and cash flow as a result. These factors should begin to abate, however, as early as the second half of the year, as higher margin oil upstream volumes and downstream projects filter into the portfolio. As such, we continue to expect improved cash generation in the coming years. Demonstrating its confidence in the forthcoming improvement, management announced its first repurchase of $2 billion for the third quarter as part of its commitment to repurchase $25 billion in shares through 2020.