Description

Shell PLC (SHEL) is a $211B market capitalization, $250 billion enterprise value integrated energy company that is headquartered in London after moving headquarters from the Netherlands.  The company reports in USD and has a liquid ADR that represents two shares. 

Despite strong stock performance over the last several years as oil prices have rebounded, the stock has been a perennial disappointment with a trailing 5-year performance of negative 90 basis points annually (price only), negative 10-yr performance of negative 40 basis points annually and negative 18-year performance of  20 basis points annually.  Activist Third Point called for a break-up of Shell in November of 2021.  While a break-up of the company has not occurred, management has shown an increased degree of discipline both in words and in actions.  This gives me confidence that the odds are in our favor that SHEL will be a reasonable holding on a total return basis if one has a longer time horizon.  The primary points of the investment thesis are below:

1.  Shell is an attractive absolute and relative value.  Shell currently trades at 3.8x forward EBITDA and 7.5x EPS.  By comparison ExxonMobil (XOM) trades at 13.7x earnings and 6.6x EBITDA and Chevron (CVX) trades at 12.2x earnings and 5.9x EBITDA. 
2. Shell is generating significant free cash flow and is increasingly showing a higher degree of discipline.  Over the LTM, the company has generated $41.7B in free cash flow (this number did benefit from $10.3B in working capital).  Management paid down $6.4 billion in debt, repurchased $18 billion in stock and paid out $7.6 billion in dividends while residual cash built by $6 billion.  Management has guided to annual free cash flow per share growth of “greater than 10%” through 2025 using $65 “normalized real oil prices.  They lowered cash capex to a range of $22-$25 billion for both 2024 and 2025.  Additionally, they have guided to a 6% FCF growth through 2020 at a normalized $65 Brent deck.  This equates to over $30 billion in FCF in 2030.  While the market has begun to take notice, Shell’s FCF generation record over the last five years has been stellar.  2017 FCF was $14.8B, 2018 was $30B, 2019 was $19B, 2020 was $17B, 2021 was $26B and 2022 was $45.8B.  Let’s remove 2022 as this was a high commodity price environment.  From 2017-2021 average annual FCF generation was $21.5B with a trough of $14.8B and a peak of $30B.  For what it is worth, using a $75 Brent slate, I believe Shell should consistently be able to produce $25-$30B in FCF annually. 
3. Shell has an unique and high-quality business mix that is underappreciated by the market.  Shell has the world’s largest LNG business that is poised for significant growth over the next several years as well as a marketing business that has potential but has been under-managed.  While renewables is a low ROCE business, they are generating in excess of $1B in adjusted earnings and noted that they expect power generation to earn in excess of $3 billion in 2030.   The Upstream business is stable and has been nicely re-positioned. 

Operations

Shell currently reports results in five different segments – Integrated Gas, Upstream, Marketing, Chemicals & Products, and Renewables & Energy Solutions (R&ES)

Integrated Gas – Integrated Gas is Shell’s largest division and should generate approximately $13B in adjusted earnings in 2023.  This segment includes Shell’s LNG business which is the world’s largest with 66MM tons of volumes in 2022.  It also includes SHEL’s gas-to-liquid (GTL) fuels and other products as well as the exploration and extraction and midstream assets needed to provide the natural gas for these markets.  The company is targeting adding additional capacity of 11MM tons of capacity by 2030 which should aid margins and profitability.  The scale of the business is enormous with 16 liquefaction plants in operation at year-end 2022. 

Upstream – Shell’s upstream business explores and extracts oil, natural gas and NGLs.  The segment also includes midstream infrastructure and I expect approximately $10.7B in adjusted earnings from the segment in 2023.  2023 liquids production is estimated to be 1.4MM boe/day and is estimated to be flat until 2030.  Shell is the largest offshore producer in the Gulf of Mexico as well as the largest foreign producer in Brazil.  The company asserts that they have cut unit development and operating costs by 50% and 25% over the past five years.  Management has actively rationalized their portfolio and claims that new project average break-evens are at $30. 

Marketing – This business includes Mobility, Lubricants as well as Sectors/Decarbonization.  Mobility includes the company’s massive retail network and EV charging services.  The company has the world’s largest lubricants business as well.  I am modeling $3MM of adjusted income.  This business earned $4B in 2020 as performance has not been great. Management is focusing on high-grading their network and is going to dispose of 500 sites.  Management notes that the convenience retail business has been growing at a mid-single digit rate. 

Chemicals & Products – This segment includes SHEL’s refining and chemical operations.  Segment earnings are expected to be approximately $3.7B in 2023.  On the chemical side the company produces base chemicals including ethylene and propylene and intermediate chemicals include styrene monomer, propylene oxide, solvents, detergent alcohols, ethylene oxide and ethylene glycol.  They have 8.1MM tons of ethylene capacity.  With regards to refining, SHEL has an interest in 8 refineries with 1.7MM barrels of capacity.  60% is in Europe, 26% in the Americas and 14% in Asia.  The company is focused on returns and “low-carbon” opportunities.  They have divested 5 refineries, closed one and transformed one into a terminal over the last three years.  Management expects adjusted earnings of $3-4B annually going forward.

Renewables & Energy Solutions – R&ES includes renewable power generation, marketing and trading of power and pipeline gas and carbon credits.  The segment includes production of hydrogen as well as carbon capture and storage hubs.  This business is expected to generated approximately $1B in adjusted earnings in 2023 and management has guided to adjusted EBITDA of $3B in 2030.  Of note, management has at least put in an un-levered return hurdle of  6-8%.  

Financials

For 2023 I am modeling $72B in EBITDA and $28B in FCF.  Using a $75 Brent price and $4.00/MMBtu Henry Hub in 2024 and 2025 I get to $69B and $70B in EBITDA and $29B annually in free cash flow.  Management has committed to 30-40% of CFO being returned to shareholders so my expectation would be that $16-$21B should be returned to shareholders annually.

Shell has a clean balance sheet with net debt of $39B or just under .5x turns of debt.  Net debt peaked at $78 billion in 2019 and has fallen by half over the last four years.  Diluted shares outstanding peaked at 8.3 billion in 2018 and have fallen to 6.85MM.  Diluted shares outstanding are down 8.8% year-over year and buybacks will continue in the 2H. 

Management

Wael Sawan, 49, was named CEO on January 1^st.  While it is early days he has said all of the right things in my view.  At the Capital Markets day in June he noted a “ruthless focus on performance, discipline and simplification” and then noted structural cost reductions of $2-$3 billion over the next several years, marginal cuts in capital expenditures, a 15% dividend increase and a minimum 2H 2023 buyback of $5B.  Wael has been at Shell since 1997 and has worked in all of the company’s core business units.  He has a MA in Engineering from McGill University in Montreal and has an MBA from Harvard.  Sinead Gorman, 46, has served as CFO since April of 2022.  She has a background as a civil engineer and has worked in Shell since 1999.  Before taking over as CFO she worked as EVP of Finance in Upstream. 

Risks

Commodity prices are the primary risk and I have no unique insight here. In particular, I believe a recession is a high probability event and that could lead to sharply lower commodity prices.  I recognize my timing here could be poor as oil prices have already moved.   

ESG and negative sentiment towards fossil fuels are a risk.   That noted, the more fossil fuels are demonized, the more capital discipline becomes en vogue among industry leaders. 

Catalyst

-Return of cash to shareholders

-increased comfort of the investment community that Shell is committed to capital discipline