Shell PLC (SHEL, Financial) is Europe's largest oil company. Headquartered in London, it is a diversified energy and petrochemical company that explores for and extracts natural gas, crude oil and natural gas liquids in its upstream sector. Additionally, the downstream section oversees pipelines, marketing, trading, supply and refining.
However, the company is becoming more involved in renewables, energy solutions and marketing. Marketing and chemicals and products were the two biggest revenue generators during the third quarter of 2023.
The quarterly revenue is presented in five distinct segments, as shown in the graph below:
Shell completes the sale of its retail business to Octopus Energy
One significant recent development is the company's decision to sell its retail business in the United Kingdom and Germany to Octopus Energy, an independent energy supplier registered in England and Wales. The sale was announced for an undisclosed amount on Dec. 5.
Zacks reported that the company decided to sell its Shell Energy retail customers, which includes over 1.3 million customers who pay for home energy and broadband services. These customers are expected to be transferred to Octopus Energy by the end of the first half of 2024.
After the acquisition, Octopus Energy will become a leading energy provider in the U.K. with a customer base of 6.6 million and will also enter the German market with an initial 300,000 customers.
Shell's announcement to sell its energy retail customers came as a complete surprise to many. Although this decision may be rationalized with the objective of achieving long-term profitability and reducing volatility, the funds obtained from the sale will likely be directed toward the most profitable business segments.
Third-quarter analysis and commentary
In the third quarter, Shell reported adjusted earnings of $6.22 billion, or $1.86 per share. GAAP earnings per share were $2.10. The results far exceeded analysts' expectations.
Total revenue for the third quarter was $78.01 billion, a 21% decrease from the previous year due to significantly lower commodity prices. Oil and gas prices, on the other hand, increased sequentially.
Several factors have contributed to the sequential increase, including supply disruptions from Saudi Arabia and Russia, OPEC+'s two major producer members.
The positive quarterly results were mainly due to the rise in commodity prices in the third quarter despite a 15.1% drop in prices year over year. During the quarter, the global liquid prices were $79 per barrel of oil equivalent and natural gas was priced at $7 per thousand cubic feet (mcf), which was down from $15.66 per mcf in the prior-year quarter.
Shell's increase in refining margins, realized oil prices, liquefied natural gas trading, optimization results and upstream production have led to a rise in profits. However, a decline in integrated gas volumes has mitigated some of these effects. Despite this increase, Shell's oil equivalent production has declined for the past four years. In light of this, the company divested its retail business to Octopus Energy and is now focusing on investing in the upstream segment, which presents more profitability and less market volatility.
The company declared a quarterly dividend of 66.20 cents per share, equating to a dividend yield of 4%.
Shell is generating great free cash flow
Let's take a closer look at the company's free cash flow as it is a crucial measure when evaluating long-term viability. Free cash flow refers to the money that is left over after subtracting capital expenditures from cash flow generated from operations. This metric indicates how secure and efficient a company's dividend is.
Based on Shell's financial statements, the free cash flow amounted to $7.50 billion. However, it should be noted it did not use the standard formula for calculating free cash flow that adheres to GAAP regulations. Instead of capital expenditures, it utilized the cash flow from investing activities.
To compare with similar companies, I will use the calculation mentioned previously. The free cash flow decreased from $10.52 billion in the second quarter to $7.07 billion in the third quarter, whereas the capital expenditure increased from $4.61 billion to $5.25 billion.
Furthermore, the cash from operations decreased from $15.13 billion in the previous quarter to $12.33 billion in the current quarter. Lastly, the trailing 12-month free cash flow stands at $41.57 billion.
Shell should focus on reducing debt
The fact the company's net debt hasn't really dropped over the last few quarters worries me a little. This situation might scare investors in 2024.
It is my opinion that Shell's management made a mistake by using its excess cash to buy back more shares rather than putting more of an emphasis on paying down the company's debt.
This decision could be beneficial, but only if the debt level is acceptable. Unfortunately, that is not the case yet. The chart below illustrates this situation. Shell's revenue for 2023 has increased significantly compared to previous years, which could have allowed the company to reduce its debt at a faster pace this year. However, the buyback program has interfered with this process.
The company's net debt has increased slightly from $40.31 billion in the second quarter of the year to $40.47 billion in the most recent quarter.
I consider this increase inappropriate, especially during times of plenty. In the third quarter, total cash amounted to $43.03 billion, while total debt reached $82.14 billion.
It is evident from the debt-to-equity ratio historical data that improvements were made starting in 2020. However, the pace of improvement slowed down significantly between 2021 and 2023.
The debt-to-equity ratio reached 0.43 in the third quarter, indicating the company's focus on share buybacks prevented it from reaching a ratio below 0.30.
Oil-equivalent production
The data shows Shell's output for the third quarter of the year was 2,653,000 barrels of oil eqivalent per day, a 2.4% decrease from the previous year.
The output includes 900,000 boepd of integrated gas and 1,753,000 boepd for the upstream segment.
Furthermore, the volume of LNG sold in was 16.01 million tons, slightly higher than the 15.56 million tons sold in the year-ago period.
Moreover, Shell has been gradually reducing its oil equivalent output since 2019 as it transitions to alternative revenue sources while maintaining a solid oil and gas industry basis. However, recent management decisions have shown some hesitancy due to the significant role of the company's oil-equivalent segments.
Finally, integrated gas and upstream adjusted earnings accounted for 76.3% of total adjusted earnings in the third quarter compared to 86.9% a year prior.
This highlights the crucial importance of these two business divisions to the company's overall performance and their role in facilitating a smooth transition to alternative energy sources, which is still a long way off.
What to expect for the fourth quarter and 2024
Shell is anticipating an integrated gas production of 870,000 to 930,000 barrels of oil equivalent per day for the fourth quarter. The company also projected 6.7 million to 7.3 million tons of LNG liquefaction volumes.
The estimated upstream production will be between 1,750,000 and 1,950,000 boepd.
There will be a 4% increase in production sequentially, but the average price per barrel of oil equivalent may slightly decrease from the third quarter.
For 2024, the forecast is cloudy. Bank of America anticipates that U.S. oil companies and refiners will face yet another challenging year. According to a Jan. 5 Reuters report, the bank wrote, "We expect oil to remain volatile, exacerbated by outsize paper market influence, informed by geopolitics and OPEC policy."
However, investors this year should not underestimate Saudi Arabia's commitment to oil. Brent could remain in a $70 to $90 band due to non-OPEC output and an uncertain demand outlook.
In short, 2024 will be less favorable for oil producers like Shell.
Technical analysis and commentary
Note: The chart above has been adjusted for the dividend.
Shell is forming an ascending triangle pattern with resistance at $67.85 and support at $64.20. The relative strength index is at 59 and increasing, which may indicate potential weakness soon after retesting resistance.
Ascending triangle patterns are considered bullish continuation patterns that typically result in a pattern breakout. However, the stock will need to retest its lower support at around $63 to $61 once more before resuming its bullish trend.
Unless oil and gas prices rise significantly, Shell's stock price will most likely fall by the end of January; thus, I recommend trading last in, first out for 50% of your position regularly to take advantage of market fluctuations during the transitional period.
I suggest selling between $67.50 and $68.50, with potential higher resistance at $69, and then waiting for a retracement between $65.33 (50 MA) and $63.50 before considering buying, with possible lower support at $61.50.
