Royal Dutch Shell plc vs BP plc: Why debt and capex plans mean only one winner

Royal Dutch Shell (LSE: RDSB) and BP (LSE: BP) are the UK’s two premier oil groups, and both companies are investor favourites. However, this year’s set of first quarter results from both companies shows that in the current environment, Shell is the better bet for investors.

Indeed, Shell’s first quarter earnings release issued today revealed that the firm had made $1.6bn in earnings in the first quarter on a current cost of supplies basis, excluding identified items down 58% year-on-year. This comfortably beat expectations. City analysts were expecting the company to report earnings of $1bn.

On the other hand, when BP reported first-quarter results at the end of April, the company reported a much larger year-on-year drop in profits than its larger peer. BP made a profit of $523m on an underlying replacement cost basis, 80% below the figure of $2.6bn reported in the year-ago period. Still, the market had expected the company to report a first quarter loss of $140m, so BP comfortably beat City expectations.

Crunching numbers

During the first three months of 2016, BP lost $747m from its upstream operations on an underlying basis and made $1.8bn on refining and trading, boosted by what the company said was an improved performance from its trading arm. Shell lost $1.4bn from its upstream activities ($994m in its integrated gas unit, which in previous quarters had been part of the upstream business) and $2bn from refining, trading, and retail.

Both companies also announced drastic cuts to capital spending. Shell, which acquired smaller BG Group in February, is cutting capital spending to $30bn this year, 36% less than the two companies combined spent in 2014 and BP is planning to cut capex to between $15bn and $17bn. Shell’s capex is the highest among its rivals, exceeding that of US rival ExxonMobil putting the company in a prime position to benefit if the price of oil returns to historic levels in the near future.

The one main difference between BP and Shell’s first quarter results was management’s tone on debt. You see while Shell is committed to reducing its debt after buying BG, BP’s managers seem to want to increase the group’s debt. The company specified alongside first quarter results that it was looking to increase gearing from a range of 10% to 20% to a range of 20% to 30% now that the company has agreed a $20bn settlement with the US authorities. Meanwhile, Shell is looking to reduce its gearing from around 25% back to a mid-teens level. Asset sales will be the main lever Shell is going to pull to reduce debt.

Both companies have forecast dividend yields of 7.2% for 2016.

The bottom line 

Overall, Shell and BP’s first quarter results were broadly similar. However, Shell is committed to both maintaining capital spending to ensure the group can continue to grow when oil prices recover and the company is also trying to clean up its balance sheet. BP it seems, is heading in the other direction. 

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Rupert Hargreaves owns shares of Royal Dutch Shell B. The Motley Fool UK owns shares of ExxonMobil. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.