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$RDSB - Stock Analysis

Royal Dutch Shell Stock Analysis - 2019 Annual Report

Shell's Story

Shell is a global group of energy and petrochemical companies with 83,000 employees in more than 70 countries. Expertise in the exploration, production, refining and marketing of oil and gas. They also invest in power, including from low-carbon sources such as wind and solar; and new fuels for transport, such as advanced biofuels and hydrogen.

Business Model

1) Exploration - Oil and Gas, Onshore and Offshore. 2) Development and Extraction - Producing conventional, deep-water and shale oil and gas 3) Manufacturing and Energy Production - Refining oil into fuels and lubricants, Producing gas-to-liquids (GTL) products, Producing petrochemicals, Producing biofuels, Generating renewable power, and Producing liquefied natural gas (LNG) 4) Transport and Trading - Shipping gas and oil to where it is needed, Trading oil and gas, and Supply and distribution of LNG for transport applications. 5) Sales and Marketing - Supplying domestic electricity, Supplying products to businesses, including gas for cooking, heating and electrical power, Progressing electric vehicle and hydrogen refuelling infrastructure, and Supplying aviation fuel. 6) Technical and business services - Researching and developing new technology solutions, and Providing technical and supporting services.

Organisation Breakdown / Segmental Reporting

Integrated Gas (Including New Energies) - Integrated Gas manages LNG activities and the conversion of natural gas into GTL fuels and other products. Also markets and trades natural gas, LNG, electricity and carbon-emission rights. New Energies - New fuels for transport, such as advanced biofuels, hydrogen and charging for battery-electric vehicles. Also includes wind and solar. 13.08% of Revenue (including inter-segment sales). Upstream - Covers Conventional Oil and Gas, Deep Water and Shales (crude oil, natural gas and natural gas liquids). 13.37% of Revenue (including inter-segment sales). Downstream - Oil Products and Chemical - Gasoline, diesel, heating oil, aviation fuel, marine fuel, biofuel, lubricants, bitumen and sulphur, and petrochemicals for industrial use. 85.47% of Revenue (including inter-segment sales). Projects & Technology - R&D and New Projects.

Market Overview In 2019

Global Economic Growth - The key uncertainty for the global economy will be the impact of the COVID-19 (coronavirus) outbreak. Will most certainly affect Q1 and Q2, and is likely to have an adverse lingering affect for the rest of FY20 and FY21. Crude Oil - Crude Oil growth has historical average growth of 1.3 million b/pd per year since 2000, this is obviously likely to decrease over time but due to emerging developing countries growing rapidily, this could be maintained for the foreseeable future (at least next 5-10 years). As of writing this (31/03/2020) Brent Crude Oil prices are 26.44, this is a drastic decrease from 2019's average of $64/per barrel. Also, as of writing OPEC caps have been lifted meaning supply for Crude Oil is set to soar along with a decrease in demand due to COVID-19, Shell is in for an extremely troublsome fiscal year (even if OPEC and Russia start to co-operate again, it will take time to recover from this aftermath). (15th April Update - Russia and OPEC have come to a supply agreement) Natural Gas - Global gas demand grew by 2.4% in 2019 (2.5% average growth yearly since 2000) because of the attractive prices compared to coal and oil in 2019. Increasing availability of low-cost natural gas and oil, combined with technological improvements, could continue to place pressure on natural gas prices. Due to cheap crude oil prices in 2020, natural gas demand is expected to be much lower than was originally estimated. As commodities, especially Crude Oil and Natural Gas are heavily correlated with global economic growth we could see a very poor fiscal year for shell in 2020 (and even 2021) as a recession looks likely. Refining and petrochemical margins are also correlated with economic and trade growth, so smaller margins along with a lower output are expected. The only positive seems to be is that the market is pricing this in to energy stocks, with the sector having taken a significant hit in valuation/stock prices.

Portfolio and Business Development

Integrated Gas Key Portfolio Events (2019) ; Two joint ventures in Dec 18, one with EDF Renewables to build wind farms off the New Jersey coast and one with EDP Renewables to build wind farms in Massachusetts - both will supply electrcity to customers in their respective states. In February Shell acquired Sonnen (a German smart energy battery storage company) and in November acquired ERM Power (Australia's leading commercial electricity retailer). Divestments (2019) ; Timor-Leste Sunrise Gas Field (interest of 26.6% sold), and 10% interest in Mahanagar Gas Limited sold (India). A lot of Shell's investments in New Energies are in sectors that are different from Shell's existing oil and gas businesses, which could be a concern in the future if they're not able to fully replace this business. Increased focus on providing energy to end-users (retail consumers), with acquisition of First Utlity in the UK in 2018 (providing renewable electricity to 900,000 homes in the UK), GI Energy in the US, and Sonnen in Germany. Upstream Key Portfolio Events (2019 ): Various new exploration finds/wins and investments in oil and gas. Ranging from Argentina to Egypt to Oceans. Divestments (2019) : - Canada, Foothills sour gas plants and fields sold. Sold interest in the Danish underground consortium for $1.9 billion. And then various divestments in the US from the sale of the Haynesville shale gas field to the sale of the Norphlet deep-water gathering pipeline system in the US Gulf of Mexico. Downstream Completed sale of 50% interest in Shell Saudi Arabia (Refining) Limited for $631 million, While in the USA their subsidiary Equilon Enterprises announces that they've reached an agreement for the sale of Martinez Refinery for $1.2 Billion. Shell is the worlds largest mobility retailer, with 45,000 service/retail stations in 80 countries (30 million customers visiting these stores buying fuel and convenience items like food, and car products). B2B occurs at Shell primarily from selling fuel to commercial airline customers and lubricants to wholesale customers (which they use for their products). Corporate The corporate segment covers the non-operating activities supporting Shell, such as holdings, self-insurance activities, and finance expenses (i.e. issuing debt). According to the Brand Finance Global 500 (2020) Shell's brand value is estimated at $47.5 Billion. In 2020, priorities for applying their cash will be; the servicing and reduction of debt commitments, payment of dividends, and then followed by a balance of capital investments and share buybacks. Liquidity - The portion of debt maturing in 2020 is expected to be repaid from a combination of cash balances, cash generated from operations, divestments and the issuance of new debt . This is concerning, and shows from a liquidity/debt position Shell is not in a great place. Add on COVID-19 and low oil price issues and we could see Shell's debt position become drastically worse. It's currently a cause of concern however could turn into a detrimental factor, and lead to avoiding investing in Shell. Lastly, they have a gearing goal of 15%-25% which is good however it remains to be seen if they can actually achieve this.

Risk Factors

Macoeconomic Risk - Fluctuating Prices of Crude Oil, Natural Gas, Oil products and chemicals. Price fluctuating can arise from supply & demand (e.g. Covid-19 or UK policy to prohibit gasoline vehicles by 2035) or Geopolitical issues (Russia-Saudi). While low prices will adversely affect revenue/profits (which in turn can significantly put the companies financial health at risk and dividend payments), high prices will also kill off demand for their products and stop some governments from even allowing Shell to use their reserves (to produce). - Shell manage this risk by ensuring they have a diversified portfolio, they also try to maintain a strong balance sheet to provide resilience against weak market prices (whether this is the case or not is another issue, while being in a strong cash flow position, the companies liability/debt position is not great). Competitors - Alot of the products Shell sell are commodity based, so no real way of differentiating their products from the competion, the main innovations/ways to get ahead are based around cost management in order to try 'stretch' profits as much as possible. Also while Shell is the biggest of the private entities in this sector (e.g. bigger than Exxon Mobil, BP, and Total SA) it also faces competition from government/state owned entities such as Saudi Aramco, China petroleum corporation, and Gasprom. The biggest issues with having state-owned competiton is that Shell could find themselves at a competitive disadvantage as governments do not need to incur compeitive returns when making decisions, being able to over-bid Shell for new leases and projects. They can also sell at a loss and dictate market conditions through supply. Divestments - Certain divestments may result in Shell agreeing to retain certain liabilities - could lead to increased liability/debt. There is also the risk that Shell are unable to find valid replacements for their divested oil and gas reserves. - Future oil and gas production will depend on access to new proved reserves (through exploration and negotiations with governments). Rising Climate Change Concerns - Could lead to more regulatory measures which could result in project cancellations and a decrease in the demand for fossil fuels. Increased regulations surrounding fossil fuels will also lead to increased compliance costs and operational restrictions. - Shell need to focus more heavily on renewable energy, as it will not only improve market perception (PR) but also provide future revenue growth/maintenance as GHG become less viable. Personally feel there is not enough focus on renewable energy, although it is better than their competitors. Assessing the overall risk of shell, it seems the company has signficant potential risk issues in a multitude of areas. Assigning a discount rate of 7%/8% seems fair due to the nature of the business (oil and gas are a finite resource), competitors (particularly from government-run organisations) and the difficulty of ensuring the energy transition is done to a high standard (it is very complex transitioning to renewable energy in an efficient manner). That being said as the company sells multiple sources of energy it mitigates the damages/risk from low prices of a certain commodity (e.g. crude oil during Russia-Saudi conflict), while Shell also use financial derivatives (futures/options) to mitigate/hedge against drastic price actions.

2020 Outlook and Beyond

25 Billion share buy back programme started 2019 (over $15 billion completed in Feb 20) however as of March 2020 it has been put on hold due to COVID-19/Oil Price plummet. - This however will/should result in maintaining the current dividend levels (still a probable chance we could see a cut). - A future dividend cut is already seemingly priced into the stocks current price however, which makes it a very attractive dividend investment (High yield due to low stock price). Investing in new Businesses and Acquisitions Oil and Gas - Shell still investing in the area (number of different regions). - Pros - there is still a high demand for oil and gas due to an increasing population and because of emerging/developing countries. Cons - could lead to the company being left behind in energy space if they give GHG too much focus, it also doesn't help PR/public perception. Purchase of ERM - New energies. Eneco - Failed acquisition - Eneco is a producer and supplier of natural gas, electricity and heat (operating in the Netherlands), serving more than 2 million businesses and resdential customers. Was eventually bought by a japanese consortium for $4.4B. - Shell seem to be disciplined with acqusitions and seemingly only buy at what they feel is a good price. Divestments and Exits from Markets Sale of Martinez refinery - Feb 2020. Divestment strategy - reshape refining efforts towards smaller, smarter refining portfolio focused on integration with Shell trading hubs.

Environment and Society

Shell have good CSR guidelines - to read more; https://reports.shell.com/annual-report/2019/servicepages/downloads/files/shell_annual_report_2019.pdf (Pg.84 - Pg.90). In 2019, Shell paid more than $61.3 billion to governments. $7.8 billion in income taxes and $5.9 billion in government royalties. Collected $47.6 billion in excise duties, sales taxes and similar levies on fuel and other products on behalf of governments. In 2019, Shell spent $44.9 billion on goods and services from 29,361 suppliers globally.

Climate Change and Energy Transition

Shell is reducing global GHG emissions in a number of ways:

■ Supplying more natural gas to replace coal for power generation;

■ Developing carbon capture and storage (CCS);

■ Implementing energy-efficiency measures in their operations;

■ Developing new fuels for transport such as advanced biofuels and hydrogen;

■ Using natural gas and renewable electricity to generate power; ■ Nature based solutions - the protection or redevelopment of natural ecosystems such as forests and wetlands, allowing those ecosystems to capture and store more carbon.

Income Statement

Balance Sheet

The two big takeaways from the balance sheet is total current assets being greater than the total current liabilities, and the drastic increase in long term debt. While total current assets have decreased by 17% over the past 10 years, total current liabilities have also decreased by over 20% so short-term liquidity for the company is better now than in 2010. Unfortunately Long term debt has increased by a staggering 136% in the same time span and while total non-current assets has increased 49%, its not great knowing this asset growth is primarily due to increased debt/leverage (this is shown by an increase in the gearing ratio of the company over time). To conclude, short term liquidity has improved but seemingly at the expense of long term liquidty - meaning for the time being debt should be fine but could become an issue if cash flow/earnings get hit like they will in 2020 (due to COVID-19 and oil prices).

Valuation

Bull Case

Neutral Case

Bear Case

Price Range - $34.49-$69.54, Following all of my qualitative analysis and the state of Shell's income statement and balance sheet, i'd lean more towards the bear case. On the 18th of March 2020 the stock fell below $20, which in my opinion showed great value as buying around that price could've gave impressive capital gains (even at the fair value Bear Case of $34). To maintain a solid risk-to-reward ratio, I personally have a buy target of >$30. In regards to when I would sell the stock - Ideally this is a long term hold due to the impressive dividend the company pays (the stock is more of a dividend paying investment than a capital gain investment). That being said if the stock price does double to the Bull Case fair value price, I would sell a decent portion of the stock to further reduce the risk of the investment (locking in capital gains never hurts), as i'm not sure how much longer the company will be able to maintain its dividend (in the next 5+ years).