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3 Reasons Why Shell (RDS.A) Fell Post Impressive Q1 Earnings

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Royal Dutch Shell plc's first-quarter report last week seemed impressive on most counts. However, the stock lost almost 2% immediately after the release. Before we delve deeper into the factors that might have disappointed the market, let’s see what looked impressive this time around.

The company reported earnings per ADS (on a current cost of supplies basis, excluding items - the market’s preferred measure) of $1.28, going past the Zacks Consensus Estimate of $1.24 and the year-ago adjusted profit of 92 cents.

Europe’s largest oil company also saw its revenues of $91,114 million clock in 24.3% above the first-quarter 2017 sales of $73,311 million and beat the Zacks Consensus Estimate of $81,020 million.

Shell was able to grow its upstream business earnings to $1,551 million (excluding items), up from $540 million (adjusted) a year ago. The surge in income from its unit, which produces oil and gas, lifted the energy group’s total earnings to more than $5 billion – the most since the days of $100 crude.

Shell's integrated gas business – consisting of the BG Group activities – also impressed. The unit reported adjusted income of $2,439 million, more than doubling from the $1,181 million in January-March quarter of 2017.

The strong performances from the upstream and the integrated gas segments more than made up for a 32% drop in earnings in its downstream business, which refines crude oil into fuels like gasoline and diesel oil.

Overall, the dramatic recovery of crude prices, coupled with the significant reduction in operating costs from 2014 levels, helped Shell to come out with strong headline numbers.

Here are the possible reasons for Shell’s price decline despite delivering best profit growth in years:

Disappointing Cash Flow: Shell earned more in the first quarter of 2018 than it did in 2014 - when oil was trading above $100 a barrel. Still, free cash flow remained essentially flat year over year. The integrated behemoth raked in $5,178 million in free cash flow during the quarter, little changed from $5,184 million a year ago. While it was almost enough to cover the dividend and interest payments, with the group’s worldwide realized liquids prices 25% above the same period last year and spending restrained, investors were looking for a far higher cash flow number. 

No Clarity on Buyback Timing: Shell has committed to buy back shares worth at least $25 billion by the end of 2020. The recent surge in Brent crude – the international benchmark – to more than $75 a barrel, raised investor expectation about an announcement on the commencement of the program. But following the weaker-then-expected cash flows, the company held off giving any firm timetable for the promised repurchase. This is a key point of investor disappointment. The aborting of its scrip dividend program in favor of all-cash payouts is likely to worsen the situation and further cloud the share buyback timeline.

Slow Progress on Debt Reduction: Despite all its efforts, the energy conglomerate reported a rise in net debt to $66,137 million as of Mar 31, 2018, from $65,944 million at the end of 2017. Again, this stemmed from stalled cash flows that left little to cut down on borrowings. Even the sequential reduction in Shell’s net debt-to-capitalization ratio was miniscule – from 25% to 24.7%.

Despite Headwinds, the Stock Remains a Buy

While the above-mentioned issues have put some pressure on Shell stock, we think the company offers substantial upside potential from the current price levels and view it as a preferred energy play to own now. This is backed by the oil major’s Zacks Rank #2 (Buy) – a notch higher than fellow supermajors Exxon Mobil (XOM - Free Report) , Chevron (CVX - Free Report) or BP plc (BP - Free Report) who currently retain a Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Last year, Shell usurped the long-held crown of larger rival Exxon Mobil to become the leading energy firm in terms of profits and cash flows as it successfully trimmed its cost base, while taking advantage of the commodity price rally. In fact, the company’s solid results over the past few quarters underscore the fact that it has successfully adapted itself to thrive at $50-barrel crude. Moreover, leverage is coming down, albeit slowly, and Shell remains on track to generate enough cash to cover all its dividends capital investment costs and the quarterly dividend.  

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