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Morningstar | Shell’s Latest Outlook Maintains Focus on Cash Flow Growth and Returns to Shareholders

With its management day on Tuesday, narrow-moat Shell extended its outlook through 2025 from the existing plan that runs through 2020. The latest plan calls for organic free cash flow of $35 billion in 2025 from a range of $28 billion-$33 billion in 2020, with returns on capital rising to 12% from 10%, and gearing falling to 15%-25% from 25%. Cash capital expenditures should tick up to $30 million on average (including about $1 billion in acquisition spending) from $24 billion->$29 billion expected through 2020, with a ceiling of $32 billion. Shareholder distributions, including dividends and buybacks, is estimated at $125 billion (nearly half its current market cap) or about $25 billion per year compared with the roughly $24 billion per year during 2018 to 2020. While still yielding a hefty 6%, Shell plans to resume dividend growth once the current $25 billion share buyback programme nears completion in 2019.

While the updated plan lacked any dramatic takeaways, we think it should be positively received by the investment community, who are likely to retain doubts about the sustainability of the capital discipline exhibited over the last few years. Our fair value estimate and moat rating are unchanged, leaving Shell on our best ideas list in the sector.

Although the new outlook addresses capital discipline, concerns might now shift toward the lack of growth. While Shell is likely to lag peers on this metric, its capital restraint does not mean it's not growing its businesses. Unlike peers, Shell continues to refrain from issuing production guidance, instead stressing value over volume. While we expect production growth to remain tepid over the forecast period, trailing peers Total and BP, volumes should continue to grow, resulting in high margin liquids volumes being added to the portfolio. This should lead to free cash flow growing to a range of $14 billion-$17 billion in 2025 from $12 billion-$15 billion in 2020.

Importantly upside also exists, with Shell laying out ambitions to reduce development and operating costs by another 20%-30% from already significantly improved levels. If achieved, this should allow for greater activity under its capital plan or greater free cash flow. In sum, while peers might boast higher headline growth rates, Shell’s upstream outlook is favorable.

Downstream segments should show improvement as well. In the oil products segment, Shell expects to grow free cash flow to $8 billion-9 billion from $6 billion-$7 billion by emphasizing growth in its more stable marketing operations. Investments in this capital-light operation, along with planned divestment of about one quarter of its refining capacity, should also lead to improved returns. In the chemicals segment, free cash flow is expected to grow to $2 billion-$3 billion from $0 in 2020 through investment in new projects.

Shell will also continue to peruse investment in its power segment to the tune of $2 billion-$3 billion per year. While the segment will be free cash flow negative of $1 billion-$2 billion per year by 2025, it should deliver earnings growth. Additionally, the steady build out of this business, like its downstream investments, further reduces Shell’s cash flow and earnings exposure to oil prices, creating a more stable business over time and addressing concerns over long-term sustainability of oil demand.