Royal Dutch Shell Plc Remains A Buy For Me Despite Profit Miss

Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) shares fell by nearly 4% when markets opened this morning, despite the firm reporting adjusted profits of $22.6bn, a 16% increase in 2013.

The final dividend also rose by 4% to $0.47, taking the full-year payout to $1.88, 4% more than in 2013.

Why are the shares down?

Shell’s share price fell this morning because the firm missed analysts’ earnings forecasts for last year. The oil and gas giant’s adjusted earnings per share were $3.57, around 4% below consensus forecasts for earnings of $3.73 per share.

The firm’s fourth-quarter results were a particular disappointment, with adjusted profits of $3.3bn, versus forecasts of $4.1bn.

However, I’d urge you to ignore today’s short-term market reaction, and focus on Shell’s underlying business, which I believe is in good shape to weather the current storm.

Cash machine

Shell cut capital expenditure by around $9bn last year, and sold $15bn of assets. This looked like a smart move at the time, but the subsequent plunge in oil prices has made the cutbacks look inspired.

The proof is in the firm’s free cash flow: Shell generated free cash flow of $25bn in 2014, compared to free cash flow of zero in 2013.

Of course, this massive improvement won’t all be repeated in 2015. Lower oil prices will reduce the firm’s operating cash flow, while $14bn of last year’s free cash flow came from asset disposals.

Shell has used last year’s windfall wisely. In addition to dividend payments of $12bn and share buybacks of $3.3bn, Shell used last year’s influx of cash to strengthen its balance sheet — doubling its cash pile from $10bn to $21bn, without adding to its debt.

Given that last year’s capital expenditure was $20bn, it’s clear to me that Shell’s financial position is now very strong.

What about 2015?

It’s worth remembering that the price of oil only really started to tumble in the final quarter of last year. Shell will obviously feel the pain of lower oil prices this year, but this impact should be cushioned by the group’s fast-rising levels of gas and LNG output, where prices are more resilient and often fixed by long-term contracts.

Shell is planning to cut a further $15bn from capital expenditure over the next three years, but chief executive Ben van Beurden has promised not to over-react to the oil price fall by jeopardising the firm’s long-term growth opportunities.

In my view, Shell remains a strong long-term income buy -- but there's no doubt 2015 could be a difficult year.

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Roland Head owns shares in Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.