Shell needs to re­pay in­vestors who backed big­gest ever wa­ger

The Pak Banker - - BUSINESS -

Royal Dutch Shell Plc is un­der pres­sure to re­ward the faith of the more than 80 per­cent of share­hold­ers who shrugged off the risks from slump­ing oil prices to back its record ac­qui­si­tion of BG Group Plc.

That won't be easy: the rout in crude has cut the value of Europe's big­gest oil com­pany to the low­est in more than 10 years and raised in­vestor con­cerns that its div­i­dend is un­sus­tain­able. Chief Ex­ec­u­tive Of­fi­cer Ben Van Beur­den, who ex­pended a lot of political cap­i­tal con­vinc­ing in­vestors that BG will help Shell ride the down­turn, has to de­liver promised ben­e­fits from liq­ue­fied nat­u­ral gas to deep­wa­ter oil pro­duc­tion as bil­lions of dol­lars of cash flow is choked off.

"The ac­qui­si­tion of BG must be a spring­board for change within the com­pany," said Chris Wheaton, an an­a­lyst at Al­lianz Global In­vestors, which backed the deal. "The group needs to be­come quicker to re­act, sim­pler, more ef­fi­cient, and more fo­cused on cash gen­er­a­tion for share­hold­ers to cope with the bru­tal re­al­ity of a more volatile and lower oil price than the world has seen over the last decade." While the ac­qui­si­tion will see the com­bined en­tity leapfrog Chevron Corp. to be­come the largest non-state oil com­pany af­ter Exxon Mo­bil Corp., its mar­ket value may be below that of Shell be­fore the col­lapse in crude prices.

Shell's B shares, the class of stock used in the trans­ac­tion, rose as much as 2.6 per­cent in Lon­don trad­ing and BG gained as much as 1.8 per­cent. Shell's Chief Fi­nan­cial Of­fi­cer Si­mon Henry said the pur­chase is pos­i­tive for cash flow at any crude price, al­though the de­cline from $50 a bar­rel to $30 cuts $8 bil­lion a year from the flows gen­er­ated by the en­larged com­pany.

"The BG deal will add to our cash flow at any oil-price en­vi­ron­ment," Henry told share­hold­ers in The Hague be­fore they voted for the deal on Wed­nes­day. Some of the eco­nom­ics of the trans­ac­tion "may in­deed be stretched in a low oil-price en­vi­ron­ment" over the next two years, he said.

The slump has been bru­tal for Shell and other oil pro­duc­ers. The com­pany's re­turns from its as­sets went below one last year for the first time since 1987, ac­cord­ing to a re­port this week from San­ford C. Bern­stein & Co.

Oil's more than 70 per­cent de­cline since June 2014 has forced com­pa­nies to write off the value of as­sets worth bil­lions of dol­lars. Shell booked a $7.9 bil­lion write­down in the third quar­ter of last year af­ter aban­don­ing projects in Alaska and Canada.

An­other met­ric CEO Van Beur­den and CFO Henry will be look­ing to im­prove is the re­turn on in­vested cap­i­tal, which has dropped to the low­est in more than 15 years. The ra­tio, show­ing the prof­itabil­ity of funds in­vested, turned neg­a­tive in the quar­ter through Septem­ber, even as Shell's re­turns ex­ceeded those of Euro­pean ri­val BP Plc.

Inevitably, those de­te­ri­o­rat­ing met­rics are flow­ing through to the bot­tom line. Shell last week said it ex­pects fourth-quar­ter profit to de­cline by at least 42 per­cent from a year ear­lier, af­ter net in­come dropped to the low­est in more than six years in the pre­ced­ing three months.

While th­ese prob­lems per­sist, in­vestors have voted through Shell's ac­qui­si­tion of BG be­cause it adds to pro­duc­tion and re­serves and makes the com­pany the largest LNG trader.

Shell says the deal will also en­hance its abil­ity to pay div­i­dends. The oil slump has sent Shell's div­i­dend yield to the high­est level in 20 years, above 8 per­cent -- a sign that some in­vestors see the pay­out at risk.

"The oil sec­tor's fi­nan­cial met­rics have been hurt by oil prices," said Ja­son Gam­mel, a Lon­don-based an­a­lyst with Jef­feries In­ter­na­tional Ltd. "Shell will need to demon­strate over the next six months what ac­tion they can take to un­der­pin the div­i­dend. They will also have to push ahead with the di­vesti­tures to pro­tect the bal­ance sheet."

Other share­hold­ers will be harder to con­vince in an era of lower-for-longer prices. "We feel that the down­side risks have not been fully re­flected," Paul Koster, head of Dutch in­vestor group VEB, said be­fore the vote in The Hague. "We would like a bet­ter un­der­stand­ing on the im­por­tance of cash flow. We are con­cerned, we can't find enough data on what will hap­pen if oil prices stay low for five years, as low as they are now."

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