Today’s profit warning looks like a good time to buy Shell

Shell: no need to panic

Shares in Royal Dutch Shell took a hit this morning as the oil major issued its first profit warning in ten years.

As the company’s new chief executive, Ben van Beurden, put it: “our 2013 performance was not what I expect from Shell”.

Adjusted earnings (which exclude one-off items and changes in the value of oil inventories) fell to around $2.9bn in the fourth quarter of 2013. That’s down from $5.6bn the year before, and well below analysts’ expectations of $4.9bn.

So what’s the problem? Should you sell? Or is this a minor buying opportunity?

Shell seems to have taken hits in most parts of its operations. As far as the business of finding and producing oil goes (its ‘upstream’ operations), exploration expenses were up, production volumes were down, and oil prices were broadly flat – which all adds up to lower profits.

Meanwhile, production of high-value oil and gas – including gas-to-liquid operations and liquefied natural gas – was hit hard by maintenance activity in the last three months of 2013. Exploration and production in the Americas remains loss-making. And in Nigeria, where output has suffered because of oil thefts, security conditions “remained challenging”.

The downstream operations – such as refining (turning oil into other goods) and distribution (for example, petrol stations) – didn’t have a good quarter either. The company suffered from “significantly weaker industry refining conditions”, especially in Asia and Europe, where there’s lots of over-capacity.

In fact, conditions are so bad, say company executives quoted by the FT, that Shell loses $10 for every barrel it refines in Singapore.

Don’t panic – this looks like ‘kitchen sinking’

This all sounds pretty grim. It’s no wonder the share price fell 4.4% immediately after the announcement.

However, it’s recovered a bit since (trading down 2% early in the afternoon). And that makes sense: long-term investors should hold their nerve and hang on to their Shell shares – or even buy some if you haven’t already.

Why? Well, the company seems determined to keep shareholders happy: in the third quarter, it raised its dividend by two cents to $0.45 a share. It will announce interim dividends for the fourth quarter on 30 January. That’s one to watch to see whether it will cut the dividend in light of the profit warning.

But that seems both unlikely and unnecessary – dividend cover on pre-warning earnings was a reasonably healthy 2.1 times. That puts it on a dividend yield of more than 5%, a good deal more than the average FTSE 100 stock.

Moreover, the dividend is paid in dollars. The greenback has been strengthening as the Fed has slowed down its money-printing – obviously, currencies can move down as well as up, but the US dollar seems a good one to have exposure to right now.

In any case, the profit warning might ultimately prove a good thing – the new boss getting all the bad stuff out of the way before he turns the company around. As Malcolm Graham-Wood, oil specialist and founding partner at Hydrocarbon Capital said on his blog (www.malcysblog.com), this looks like a case of an incoming chief executive deciding “to clear the decks and leave himself a decent starting point to what might be ten years in the job”.

My colleague Phil Oakley wrote in more depth about Royal Dutch Shell in a recent issue of MoneyWeek magazine and he hasn’t changed his mind on the stock. If you’re not already a subscriber, you can get your first three issues free here.

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3 Responses

  1. 19/01/2014, gamesinvestor wrote

    “” But that seems both unlikely and unnecessary – dividend cover on pre-warning earnings was a reasonably healthy 2.1 times “””

    This is a classic mistake. This a 2.1 times EPS which is a very poor measure of safety.
    Fact is against free cash flow the dividend wasn’t covered so it’s majorly at risk. If you are happy to invest in a company who’s share price is falling consistently since the start of 2012 and is still in decline, can not generate sufficient cash flow to properly cover the dividend and fails to record a record profit during a period in time when oil has been $120 to $140 for the bulk of the recent years – go ahead.

    With oil prices heading for sub $90 you’d be hard pushed to believe that the next couple of sets of results will be substantially of better quality.

    Still there’s no separating a fool and his money.
    What was it the old saying? —- “Never sell Shell”

    Maybe it should be “Shell out your money?, Never”

  2. 20/01/2014, Tomorrow Swirled wrote

    “The greenback has been strengthening as the Fed has stopped printing money”

    When did that happen – did I miss something? Didn’t the Fed in fact just slightly reduce the breakneck pace at which it is still printing money?

  3. 20/01/2014, Moderator wrote

    Tomorrow Swirled: No, you didn’t miss anything – you are quite right. Thanks for pointing that error out, we’ve amended the article.

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