Morningstar | Shell Starts to Deliver the Cash in 3Q; Remains One of Best Ideas in Sector
Shell reported a stand out quarter that demonstrates the firms’ potential cash flow generation. Operating cash flow increased 59% to $12.1 billion from $7.6 billion the year before on a 38% increase in earnings. Shell has been plagued in recent quarters by one-off items that negatively impacted its cash flow generation and left the market disappointed, but this quarter provides a truer picture of its potential in our view and supports our thesis for growing long-term free cash flow. That said, working capital continued to be a drag due to higher oil prices and greater inventory associated with downstream and trading operations, which likely explains the market’s muted response. Excluding a working capital build during the quarter, however, operating cash flow was $14.7 billion. The strong results prompted management to announce a second tranche of its planned buyback while increasing the amount to $2.5 billion from $2.0 billion last quarter. We think the strong quarter should serve as greater evidence of Shell’s potential to the market and increase confidence it can deliver on its 2020 cash flow goals and plans repurchase to $25 billion in stock. Our fair value and narrow moat rating are unchanged leaving Shell as one of our best ideas among integrated oils.Earnings increased to $5.8 billion from $4.2 billion the year before on the strength in the integrated gas and upstream segments which benefited from higher oil and gas prices.
Integrated gas earnings increased to $2.3 billion from $1.3 billion on higher realized prices and trading margins despite an 8% decline in volumes due to maintenance activity. Upstream earnings increased to $1.9 billion from $562 million a year ago thanks to higher oil and gas prices. Production increased 1% but was 4% higher excluding portfolio effects on new field start and ramp ups. The downstream segment proved the lone weak point, with earnings slipping to $2.0 billion from $2.7 billion last year primarily on weaker refining and trading results.
For more on our integrated oil outlook, see our Sept. 4 report: "Integrated Oils: A Free Cash Flow Story."
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