After another strong quarter of the third quarter, Royal Dutch Shell (New York Stock Exchange:SHEL) is on track to retire record profits from fiscal 2008, when the energy giant racked up profits of $31 billion. In the September quarter, Europe’s largest energy company generated net profit of $6.74 billion, generating YTD revenue to $30 billion. Additionally, over the past 3 months, Shell has distributed $6.8 billion to shareholders and expressed a commitment to further increase distributions.
Looking at Shell’s exceptional third quarter results, it’s hard not to like an investment. I continue to have a ‘Buy’ rating and have improved my base case price target to $99.52/share, from $70.22/share previously.
Shell September Quarterly Results
In the context of high energy prices, Shell continues to enjoy exceptional profitability. From July to the end of SeptemberThe energy giant generated total revenue of $98.8 billion, slightly above analyst consensus but lower than the $103.1 billion achieved in the same period a year earlier.
Adjusted EBITDA nearly doubled compared to the third quarter of 2021, increasing to $12.5 billion from $6.8 billion previously. Net income for the September period jumped to $6.7 billion (versus an approximate loss of $500 million in the third quarter of 2021).
CEO Ben van Beurden commented:
We are delivering strong results at a time of continued volatility in global energy markets. We continue to strengthen the Shell portfolio through disciplined investments and transform the company for a low-carbon future. At the same time, we are working closely with governments and customers to address their short- and long-term energy needs.
Profitability still at record levels
Investors should note that Shell’s fiscal 2022 profit, which has already reached $30 billion in the past nine months, is poised to break the company’s record set in 2008, when the energy giant generated $31 billion of net income.
Shell’s exceptional profitability is fueled by high energy prices, which continue to be 2x to 3x from 2020 levels (see Henry Hub Nat Gas and Brent Oil benchmark). And while refining margins are falling compared to the record high in Q3 2022, they remain elevated at close to $100/tonne (after being close to zero in the same period a year earlier).
And personally, I don’t see Shell’s profitability being threatened in the short to medium term future as OPEC+ has taken steps to keep oil close to $100 a barrel.
Attractive distributions for shareholders
Investors are pleased to learn that the majority of Shell’s record returns have been and will continue to be distributed to shareholders, with total distributions exceeding 30% of CFFO. In the second quarter, Shell bought back about $6 billion worth of shares and distributed about $2 billion in dividends.
And with the third quarter results, Shell announced that the company is targeting a further $4 billion in buybacks by the end of the fourth quarter of 2022, as well as plans to increase dividends (by March 2023), by an expected 15%, subject to Board approval.
Meanwhile, Shell defaulted on debt in the third quarter of 2022. In fact, net debt increased slightly by around $1.7 billion, to $48.3 billion.
Valuation still attractive
After another very strong quarter, I have updated my residual earnings model for SHEL to account for preliminary consensus EPS updates. However, I am still stuck with a 9% cost of capital and a 0% terminal growth rate (which I still consider very conservative).
Given the EPS updates as highlighted below, I now calculate a fair implied share price for SHEL of $99.52, compared to $70.22 per share previously. (SHEL reference)
Below is also the updated sensitivity table.
As I see it, there hasn’t been a major risk update since I last covered SHEL stock. Therefore, I would like to highlight what I have written before:
My thesis is related to the implication that there are no structural differences between European and US oil majors. This, however, is not necessarily true as the respective regulatory exposure is somewhat different. The European Union is arguably a bit more aggressive about pushing green energy and US stocks generally trade at a premium. However, a 100% relative valuation discrepancy is not justified, in my opinion.
Also, investors should note that I am assuming a sustainable oil price of around $60/bbl. While this may seem bearish to some readers, others might argue that the fair value of oil is much lower. As the COVID-19 induced sell-off in 2020 has shown, oil may even trade at negative price levels. If oil were to break significantly below $60 a share and not recover within a reasonable period of time, the bull thesis for Shell would be broken.
Furthermore, I would also like to highlight that Shell could be affected by higher tax rates, as European governments are stepping up their ‘windfall tax’ ambitions. and Shell CEO Ben van Beurden indicated that your business would be ready to ‘adopt’ higher tax rates:
We should be prepared and accept that our industry will also be looked at for raising taxes to finance transfers to those who need it most in these very difficult times… We have to accept it.
While the ‘incremental fiscal risk’ cannot yet be quantified, investors should monitor the situation closely.
The value thesis for Shell remains very strong as the energy giant continues to enjoy record profitability and distributes much of the “window gains” to shareholders. Personally, I am confident in reiterating a ‘Buy’ rating on SHEL stock. And in the context of EPS updates, I now calculate a fair implied share price of $99.52 (reference SHEL).