Shell upside surprises can keep coming this year

Shell confounds

Shell synergies keep confounding; mostly to the upside. But quarterly profits that only nudged above expectations and signs that the gush of recovering cash flow has peaked, upended its shares on Thursday morning. To be sure, shares had been down as much as 5% earlier, but recouped considerably to some 1% lower at the time of writing. Underlying annual profits doubling to $16bn indicate that the group thrived in FY2017 - with a few disappointments. These let downs focus on production and quarterly cash flow. Additionally, shareholder reactions to charges related to U.S. tax reform over the last few weeks have been unpredictable. Shell’s $2bn charge is at the lower end of necessarily imprecise guidance offered with Q3 commentary. Combined with group expectations reforms offer long-term benefits, tax concern should fall from here.

Production

On production, it’s possible some investors were somewhat over-impressed by the rate of the group’s disciplined but proactive approach to new project launches. Production growth rose in Q4 but fell 4% for the year, compared to the modest rise expected by many. As the divestment programme winds into the final phases planned some two years ago, forecasting production snap shots will continue to have mixed results. On balance, we read the 2018 shortfall relative to expectations as an ‘optical’ rather than a performance issue, for now. In fact, Shell has kept production assumptions modest since beginning to reorient to lower price forecasts. And refinery availability is capped in the first quarter, meaning flat production prospects can roll on at least into the first half. Average oil production per day forecasts should now be stable around an expected 0.8% down tick for the year. Stable expectations should help manage expectations this year.

Cash flow

Positive cash flow surprises continue to be thrown out from additional BG synergies and cost discipline predicated on a far later oil price recovery than expected. It would be unwise to rule-out scope for further unforeseen advances, despite the 21% quarterly fall. At some point, working capital effects were going to reappear. They did in Q4 to the tune of $894m. With the target for $30bn in asset sales on track, but still ahead, plus further positive synergy and cost effects likely, we stick with the view that we have yet to see the final gradient of Shell’s cash flow growth.

Of course, investors are eyeing potential dividend raises or share buybacks from buttressed cash flow. A lower than forecast quarter in cash flow could reduce such prospects, though the long-term path does not look unfavourable. Oil prices are the obvious wildcard; one reason for Shell shares reflecting increasing caution of late after rising 70% over two years.

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