The Country Caller discusses whether investors should consider putting their money in Shell or notEfficient Downstream SegmentBenefit from Lower CostsConclusion
Along with recovery in oil prices, Royal Dutch Shell plc (ADR) (NYSE: RDS.A) stock has also shown positive momentum as it has surged 7.05% year-to-date. Also, investor confidence in the company has improved considerably, as witnessed by the 22% hike in stock price over the past three months. The Country Caller explains whether this appreciation in stock price is sustainable or not.
Efficient Downstream Segment
Shell has strived to improve the efficiency of its downstream segment. It has achieved this by implementing better-quality feedstock and improving supply, thus enjoying better returns on its portfolio. Also, its cash flows and earnings have improved substantially in the past. Since 2007, the company has reduced its refining capacity as well, but was still able to keep its profitability intact, as illustrated below:
Moreover, the refining segment’s future prospects are also on the brighter side. This year, refining margins have not been as high as they were last year. The refining crack spread for East Coast averaged around $6.31 for 1QFY16, down from 10.44 a year ago. Similarly, Gulf Coast margins are also on the lower side this year.
Such lower margins are expected on the back of lower gasoline demand. But as time progresses, seasonal demand would improve as summer season is approaching . Hence, improvement in gasoline demand would improve crack spreads and enable Shell to improve the performance of its downstream segment.
Benefit from Lower Costs
In order to avoid the kind of poor performance the company had to witness last year amid falling oil prices, Shell has taken aggressive measures to cut its costs. Last year, it reduced its expenses by $12.5 billion by lowering operating and capital costs.
Similarly, Shell has plans to reduce its costs this year as well, as it has targeted to lower costs by another $3 billion during FY16. Also, the company has become selective in making investments by investing in projects which can create better wealth for shareholders. Last year, it approved only four projects out of which three were for its downstream segment. Shell plans to lower costs, reserve cash and liquidity, and avoid unnecessary expenses.
On the back of better downstream segment performance and measures to cut costs, Shell appears to be headed in the right direction. Also, once oil prices recover as even Non- Organization of Petroleum Exporting Countries (OPEC )members expected to reach an agreement on incorporating a production freeze after the OPEC meeting . If this happens, performance of Shell’s upstream segment would also improve substantially.