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Europe’s largest oil company Royal Dutch Shell plc (RDS.A - Analyst Report) reported better-than-expected third quarter 2012 earnings on the back of solid operating performance and improved refining margins.

Earnings per ADR (on a current cost of supplies basis), excluding one-time items and gains or losses from inventories, came in at $2.09, above the Zacks Consensus Estimate of $2.07.

However, compared with the year-ago period, Shell’s adjusted earnings per ADR declined 6.7% (from $2.24 to $2.09), while revenues were down 9.2% to $112.1 billion, reflecting depressed crude and North American gas prices.

Segmental Performance

Upstream: Upstream segment earnings during the quarter (excluding items) were $4.9 billion, down 10.1% from $5.4 billion (adjusted) earned in the year-ago period.

This primarily reflects the impact of lower liquids realizations, depressed natural gas prices in North America, higher depreciation and exploration expenses, Hurricane Isaac-related shutdowns in the Gulf of Mexico offshore operations, together with planned maintenance activities that adversely impacted production. These factors were partly offset by higher contribution from Integrated Gas.

Upstream volumes averaged 3.0 million oil-equivalent barrels per day (MMBOE/d), down 1.0% from the year-ago period. Natural gas volumes rose 3.5%, while crude oil output dipped 4.6% from the corresponding period last year.

Crude oil contributed approximately 54% of total volumes, while natural gas accounted for the rest. Excluding the effects of lost production on account of divestments and other reasons, Shell’s output was 1% higher than the year-earlier level.

Production during the quarter compared with the year-ago quarter included volumes from new field start-ups and the continued ramp-up of existing fields, which boosted output by roughly 163 MBOE/d.

Shell’s worldwide realized liquids prices were 5% below the year-earlier level, while natural gas realizations decreased by 3%. In particular, natural gas prices in North America plummeted 38% from the year-earlier level.

LNG equity sales volumes of 4.97 million tons were 4% higher than the year-ago quarter, mainly due to contribution from the Pluto LNG development in Australia.

Downstream: In the Downstream segment, the Anglo-Dutch super-major recorded a profit (excluding items) of $1.7 billion as against adjusted earnings of $1.8 billion in the year-ago period. The downtrend reflects the impacts of the worldwide economic turmoil, rising oil prices and Hurricane Isaac-forced disruptions.

To some extent, these factors were offset by increased refining realizations, solid operating performance and lower operating expenses.  

Cash Flow

During the quarter under review, the group generated cash flow from operations of $9.5 billion, returned $2.9 billion to shareholders through dividends/share buybacks and spent $8.8 billion on capital projects.

Balance Sheet

As of September 30, 2012, the group had $18.8 billion in cash and $36.4 billion in debt (including short-term debt). Net debt-to-capitalization ratio stood at approximately 8.6%.

Outlook, Rating & Recommendation

Royal Dutch Shell – Europe's most valued oil company, ahead of BP plc (BP - Analyst Report) and Total SA (TOT - Analyst Report) – owns one of the largest integrated oil and gas businesses in the world. The group has operations all over the world and is involved in various activities related to oil and natural gas, chemicals, power generation, renewable energy resources and other energy-related businesses.

The Hague-based group continues to make solid progress with its long-term strategic plan that aims to cope with significant energy price fluctuations stemming from economic and political developments. With a capital expenditure war chest of $32 billion in 2012, the company’s financial and production growth plans are well on track.

Shell has been looking to boost returns and remain competitive by embarking on aggressive cost reduction initiatives, exiting unprofitable markets, refocusing its efforts on emerging economies and streamlining the organization.

However, Shell is particularly susceptible to its high exposure to the downstream business, its major natural gas focus, as well as lofty capital spending, which may result in reduced returns going forward.

Royal Dutch Shell ADRs currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. We are also maintaining our long-term Neutral recommendation on the stock.

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