Shares in Royal Dutch Shell (LSE: RDSA) (LSE: RDSB) have risen by over 4% today even though the company reported a challenging second quarter of 2015. In fact, Shell’s earnings fell by $1.7bn versus the second quarter of 2014 which, given the drastic fall in revenue compared to the same period, may not have been such a bad result. Indeed, Shell’s sales fell from $115bn in the second quarter of 2014 to $74bn in the same quarter of this year, as a lower oil price heavily impacted on its top line performance. Furthermore, a year-on-year fall in production of 11% versus the second quarter of 2014 also contributed to lower overall sales.
Looking ahead, Shell expects a prolonged downturn for the oil sector and is seemingly not anticipating a return to $100 per barrel oil anytime soon. As such, costs are going to be cut and efficiencies will be made, with Shell planning on cutting operating costs by $4bn, with 6,500 job cuts being planned so as to reduce total operating costs by as much as 10%. In addition, capital expenditure is expected to be cut by a further $3bn this year to bring it down to $30bn, with further cuts planned in 2016.
Despite the challenging outlook, Shell remains a financially sound business. This is evident in the fact that it is progressing with its £47bn acquisition of sector peer BG, and has also announced a £25bn share buyback programme. Furthermore, it will maintain dividends at their current level throughout the remainder of 2015 and also in 2016. As such, Shell could be set to deliver an income return of over 13% during the next two years, which is hugely appealing.
Of course, the oil price is having a major impact on the company’s profitability and, while it is challenging for Shell’s investors, it could be a good thing in the long run. That’s because, as today’s results have shown, Shell is one of the strongest operators within the oil industry in terms of its balance sheet and cash flow and is therefore able to work a low oil price to its advantage. For example, it is in the process of increasing its market share through acquisitions and, while a low oil price is hurting its profitability, it is probably doing more damage to the income statements of most of its rivals, thereby strengthening Shell’s position on a relative basis.
Shell’s share price performance in 2015 has been disappointing, with it falling by 17% since the turn of the year. As such, it now trades on a price to earnings (P/E) ratio of just 14.4, which indicates excellent value for money and the scope for a significant upward rerating over the medium to long term.
Clearly, Shell is operating in highly uncertain times and, as today’s results show, it is being forced to adapt and change its business plan to respond to an ultra-low oil price that seems to be here to stay for the medium term. However, it is responding extremely well and has a sound strategy that balances sensible cost reductions and growth opportunities alongside a commitment to deliver value to shareholders. Together, they make Shell an excellent proposition and, for investors who can live with a time of great change for the oil industry, it remains a superb long term investment opportunity.
