Shell cash flow gushes higher shares not so much

Summary

Royal Dutch Shell’s operating cash flow continued to gush in the third quarter, offsetting somewhat disappointing profits.

Cash still key

Headline Shell earnings slightly missed market expectations, so the stock, which had been on its way back to positive territory for the year, will now wait a while longer to get there. For some time though, robust profits – a large chunk of which stem from lower costs—has not been the stock’s main attraction. Rather, cash is the key. The 51% surge to a four-year high in attributable earnings was impressive. But a near-60% bound in cash flow from operations to $12.1bn, and $14.7bn, ignoring one-offs, was more notable. The news feeds into anticipation that even after announcing a long-awaited $25bn share buyback programme in July, Shell could do more. Unlike BP, which resumed funding of project expenditure from cash in the most recently ended quarter, Shell was already covering capital investment and dividend payments from $9.5bn in cash generated in Q2. With a strong Q3 performance in the bag, the group looks on track to at least meet a 2020 goal of $25bn-$30bn in annual organic free cash flow, set in 2017. The goal was predicated on oil at $60 a barrel, but the upper end of the range may be in view with oil prices above $70/bbl. since March. Shell’s humongous cash return drive, which also has a 2020 end date, could yet step up a gear.

Uncertainties remain

To be sure, there is no direct hint of an upgrade in the quarterly report. The second tranche of the buyback programme—up to $2.5bn—was launched at a size in line with expectations. The quarterly dividend is as planned at $1.41 per share, with only a slim chance of a rise when Q4 results are announced on 31^st January. Broader uncertainties that undermine the case for higher attributable cash flow also remain. For one, production is still throwing off negative surprises. There was a 2% shortfall relative to expectations in Q3. Output is expected to swing higher in Q4 as maintenance subsides, but investors might well wish they had a better handle on these probabilities. As well, as BP signalled earlier this week, weaker refining margins are setting in across the industry. These will drag profits, albeit the UK’s No. 2 oil giant suggested the phase would pass by no later than H2 2019. For Shell, gearing, which barely inched down to $23.1% with net debt at $60.5bn in Q3, is another not quite latent concern. Shell remains the most-geared of closely matched E&P groups with a net debt ratio that is around a third higher than last year’s core earnings. As international trade conditions get more restrictive, the global economy is on its way to an unmistakeable pause, at best. That could yet bring the end of the recent cycle demand cycle, putting higher shareholder returns further out of reach. This year, Shell shares have taken a round trip spanning an 11% loss by 19^th March and a 12% rise by 21st May. With shares around 0.6% lower for the year on Thursday, a modest 2018 gain looks the best shareholders can hope for. If so, a lacklustre stock performance despite rude financial health suggests the shares could struggle to do better in 2019.

The big picture for Shell shares is that they continue to extend the distinct rising trend that began in January 2016 and one that, since September 2016, has been underpinned by a well corroborated trendline. That is the longer-term backdrop against which to view shorter-term price action.

In the daily view, the descending triangle retracement from the year’s 2755p highs in May remains present, albeit it looks messier. Nevertheless, the structure is valid. Hence, it’s therefore cogent to frame the stock as following a medium-term consolidation that will run its course at the apex. From a continuation perspective, at a minimum, a break out would happen to the higher side of the triangle if the gentle long-term rising trend continues. Backing the bigger motif, a large flag continuation pattern is also visible. Price has obediently followed the channel since April, again apart from a transgression topside in late-September-early-October. In order to invalidate prospects of a medium-term advance, not only would failure be required amid a triangle break out, but our hypothesis that the flag will eventually be bullish would also need to be disproved. Fair warning of such an eventually would be if 2338p support, where selling was sharply rejected last week, failed to withstand a further hit. Trade below 2338p would move the focus on to support created in March at 2166p.