The scrutiny of Shell’s emissions reduction targets is intensifying and speculation is focused on whether it will relax its decarbonisation goals in pursuit of more oil and gas production.
Energy majors that have remained wedded to hydrocarbons have been better rewarded by investors. Just take a look at the performance of Shell versus BP, even before the abrupt exit of the latter’s boss: Shell’s share price return amounts to 166 per cent over the past three years as soaring commodity prices turbocharged a post-pandemic rebound; BP’s pivot to renewables has seen its shares lag not only those of Shell but also their peers in the United States.
Shell’s exposure to liquified natural gas is seen as a key driver of future cashflows. During the first half of this year, the integrated gas division was the largest contributor to its adjusted earnings, turning out $7.4 billion. Analysts at RBC Capital estimate that LNG — both trading and production — accounted for 35 per cent of cash generated by Shell. The group is aiming to grow its LNG production volumes by between 25 per cent and 30 per cent by the end of the decade.
It has built a 20 per cent market share, which brings with it several advantages. In a concentrated market, Shell has a high level of visibility over future demand. If demand sags in one market, it has the ability to ship the product elsewhere via its vast trading operation.
At its June capital markets day, Wael Sawan, the Shell boss, set out plans to invest $40 billion in oil and gas production and trading from this year to 2025, or more than half its capital expenditure over the total budget over that period. That compares with the $10 billion to $15 billion directly in low-carbon products.
The cash being generated by the business over the next two years is forecast to easily cover that capital expenditure bill. Free cashflow pre-dividend payments should amount to $23.5 billion this year, rising to $24.2 billion next year, think analysts at RBC Capital. Analysts there expect the oil price to remain higher for longer.
The balance sheet is also in good shape. At $40.3 billion, net debt is more than 40 per cent lower than it was at the end of 2019, which eases one drain on cash generated by the business. That equates to leverage of just over 17 per cent. It expects to be able to afford to pay dividends even at $40 a barrel, less than half the present price of Brent crude.
Shell’s transition tension is hardly without its challenges. An enterprise value of 3.8 times forecast earnings before interest, taxes and other deductions leaves it valued at a steep discount to those US peers. A more lax focus on green strategies among large American investors could be one reason. A Dutch court ruling ordering the business to make steeper emissions cuts also remains outstanding, a decision that Shell is appealing against. Further down the line, the existential challenges are likely to become more pressing.
Shell still aims to reduce its net carbon intensity by 20 per cent by the end of the decade, but “the trajectory through which we reach that target will reflect the pace of demand changes”. That said, “the need for energy security means hydrocarbons will remain an important part of the energy mix”.
Yet it has also also provoked criticism from environmental groups by pledging to “stabilise” oil production, replacing plans to reduce output by 1 per cent to 2 per cent each year, after making steeper cuts than expected to date.
A shakier outlook for commodities prices would focus more attention on Shell’s commitment to oil and gas production.
ADVICE Hold
WHY The shares are cheap but that reflects exposure to volatile oil and gas prices
Croda International
One profit warning presents investors with a dilemma. Two seem like a sign of more disappointment to come. For Croda International, the odds of a third strike are growing.
The chemicals group has cut its profit guidance again to between £300 million and £320 million, from £370 million to £400 million, an outlook that had already been lowered in June.
Diversity has not saved sales. Customers, spanning cosmetics groups to agricultural suppliers of seeds and pesticides, are running down stocks after two years of piling them higher. Croda thinks there is only one more quarter or so of destocking for its higher-margin crop protection business and another two for the consumer care unit. Steve Foots, its chief executive, doesn’t expect a “hockey stick” recovery, but does anticipate progressive growth over the next few quarters.
Timing that recovery has been complicated by the economic downturn and its impact on Croda’s end markets. It’s not clear just how much of this year’s decline is a consequence of the inflationary pressures dampening demand. The consumer care business, which provides the active chemical ingredients for beauty products, has felt the chill of weaker discretionary spending, particularly in North America.
Investors have already shifted their expectations downwards. The shares trade at just over 21 times forward earnings, almost half the peak hit at the end of 2021. That might look cheap, but a cut in profit guidance of a similar magnitude as the latest warning would push its forward earnings ratio up towards 29.
Croda typically has only two weeks’ visibility over orders, which means revenue can be volatile. Its vulnerability to another profit warning is more acute than usual. Sales volumes are down across multiple fronts, which should have an outsized impact on margins.
Analysts think sales and pre-tax profit will return to growth next year. Any recovery could be muted if it turns out that financial pressures are a bigger factor in constraining sales than had been thought previously. That will not start to become apparent until later in the year.
ADVICE Avoid
WHY Risk of another warning does not look fully priced in
