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Has Shell’s Leverage Trend Reversed?

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Shell’s leverage position

Royal Dutch Shell’s (RDS.A) net debt-to-adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) ratio rose from 0.60x in 1Q15 to 1.9x in 1Q17. That was due to a fall in adjusted EBITDA coupled with a rise in net debt. Shell’s net debt rose steeply in 1Q16, mainly due to the acquisition of the BG Group.

In 1Q17, Shell’s net debt more than tripled over 1Q15. That was led by a 109.0% rise in total debt coupled with a 1.0% fall in cash and equivalents in 1Q17 compared to 1Q15.

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After the acquisition, Shell’s cash fell from ~$32.0 billion in 4Q15 to ~$11.0 billion in 1Q16. However, now its cash reserves have recovered to ~$20.0 billion in 1Q17. Also, Shell’s total debt rose from ~$58.0 billion in 4Q15 to a high of ~$98.0 billion in 3Q16. Now it has tapered to ~$92.0 billion in 1Q17. Thus, Shell’s net debt rose from ~$26.0 billion in 4Q15 to ~$72.0 billion in 1Q17.

Peer leverages

Shell’s net debt-to-adjusted EBITDA multiple is higher than the industry average of 1.7x. This average considers 13 integrated energy companies worldwide, including the Norwegian company Statoil (STO), the Argentinian company YPF (YPF), China’s PetroChina (PTR), the United Kingdom’s BP (BP) and Royal Dutch Shell (RDS.A), and the United States’ ExxonMobil (XOM) and Chevron (CVX).

For exposure to international stocks except for the United States, you can consider the Vanguard FTSE All-World ex-US ETF (VEU). But if you’re looking for exposure to large US companies, you can consider the SPDR Dow Jones Industrial Average ETF (DIA) and the SPDR S&P 500 ETF (SPY). Both ETFs have a ~6.0% exposure to energy sector stocks.

What does Shell’s leverage analysis suggest?

In the past few years, Shell faced the problem of lower oil prices. In that scenario, the acquisition of the BG Group led to a steep upsurge in its debt levels. However, in the past couple of quarters, Shell’s net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio has fallen. That’s due to the rise in oil prices, leading to a surge in its earnings.

Jessica Uhl, Shell’s chief financial officer, stated in the 1Q17 earnings transcript, “Shell’s financial framework is a key element of our overall strategy. There is no change to the priorities for cash flow. Reducing debt. Paying dividends and turning off the scrip, followed by a balance of capital investment and share buy-backs. We are working four performance levers to manage the financial framework: divestments, capex, opex and new projects.”

So if Shell utilizes its four performance levers according to plan, then in the scenario of rising oil prices, Shell should likely see improvement in its earnings, a rise in its cash flows, and a fall in its debt.

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