BP vs Shell: how safe are returns in 2020?
BP and Shell have both posted a steep drop in earnings in 2019 on the back of lower oil prices and there are concerns this could continue to weigh on cash flow – and therefore returns – over the coming years.
BP and Royal Dutch Shell have both reported a steep decline in profits in 2019 after average oil and gas prices were more than 10% lower than the year before. However, markets responded very differently to each company’s set of results – with Shell, which reported first on 30 January, seeing its shares fall while BP shares rallied after its results were released on 4 February.
BP vs Shell: Q4 2019
BP posted a 6% decline in revenue in the fourth quarter (Q4) of 2019 and said underlying replacement cost profit, its favoured metric and the one followed by analysts, dropped by more than a quarter to $2.6 billion – but this still comfortably beat expectations of $2.08 billion.
Meanwhile, Shell said the drop in revenue was more pronounced, falling nearly 19%, while current cost of supply profit, its equivalent metric followed by the market, plunged by 49% to $2.9 billion, falling short of the $3.2 billion expected by analysts.
|Q4 2018||Q4 2019|
|Revenue||$76.9 billion||$72.2 billion|
|Underlying replacement cost (RC) profit||$3.5 billion||$2.6 billion|
|Pre-tax profit||$2.4 billion||$249 million|
|Profit||$766 million||$19 million|
|Earnings per share (EPS)||3.83 cents||0.09 cents|
|Operating cash flow||$6.8 billion||$7.6 billion|
|Dividend||10.25 cents||10.25 cents|
|Q4 2018||Q4 2019|
|Revenue||$104.6 billion||$85.1 billion|
|CCS earnings||$5.7 billion||$2.9 billion|
|Pre-tax profit||$7.9 billion||$2.8 million|
|Profit||$5.6 million||$965 million|
|EPS||68 cents||12 cents|
|Operating cash flow||$22 billion||$10.3 billion|
|Dividend||47 cents||47 cents|
Source: company reports
BP vs Shell: FY 2019
Over the full year (FY), BP’s results proved more resilient than Shell in most areas. BP’s revenue fell 7% while underlying RC profit fell 21%, compared to Shell’s 11% fall in revenue and 23% fall in current cost of supplies (CCS) earnings.
|FY 2018||FY 2019|
|Revenue||$303.7 billion||$282.6 billion|
|Underlying RC profit||$12.7 billion||$10 billion|
|Pre-tax profit||$16.7 billion||$8.2 billion|
|Profit||$9.4 billion||$4 billion|
|EPS||46.98 cents||19.84 cents|
|Operating cash flow||$22.9 billion||$25.8 billion|
|Dividend||40.5 cents||41 cents|
|FY 2018||FY 2019|
|Revenue||$396.6 billion||$352.1 billion|
|CCS earnings||$21.4 billion||$16.5 billion|
|Pre-tax profit||$35.6 billion||$25.5 billion|
|Profit||$23.4 billion||$15.8 billion|
|EPS||282 cents||197 cents|
|Operating cash flow||$53.1 billion||$42.2 billion|
|Dividend||188 cents||188 cents|
Source: company reports
BP vs Shell: focus is on debt, cash flow and shareholder returns
The main revelation that emerged from the pair’s results is that BP looks more comfortable with lower oil prices going forward than Shell. Both companies must continue to invest in growth but also have mountains of debt to pay down and dividends and share buybacks to consider, but that is becoming harder as cash flow tightens in light of lower oil and gas prices.
Both companies have completed some costly acquisitions in recent years, which has pushed debt higher. BP splashed out $10.5 billion on a string of US shale assets from BHP Group in 2018 while Shell splurged over $50 billion on BG Group in 2016. At the end of 2019, BP had $43.5 billion worth of net debt with gearing of 31.1%, while Shell had $79.1 billion and gearing of 29.3%.
Meanwhile, Shell’s spending is on the rise while BP’s is remaining steady. Shell’s capital expenditure totalled just under $23 billion in 2019, but that is expected to rise toward the lower end of its $24 billion to $29 billion range for 2020. BP spent $15.2 billion but said this should remain at the lower end of its $15 billion to $17 billion range going forward.
An important difference that emerged from the pair’s results was cash flow. BP’s operating cash flow managed to cover its capital expenditure, dividends and finish off its share buyback programme, while Shell failed to do so and was forced to slow the pace at which it repurchases shares so it can prioritise reducing debt.
As a result, BP lifted its dividend for 2019 to 41 cents from 40.5 cents the year before, while Shell kept its payout flat at 188 cents. BP managed to finish off its latest buyback programme, which are used by both companies to offset the dilution caused by investors using scrip alternatives to take more shares in lieu of dividend payments, in January 2020, and said it would not offer a scrip alternative for the foreseeable future. This means BP doesn’t have to fret about funding buybacks going forward and gives it more wiggle room to raise the dividend or channel the funds into spurring more growth or to pay down debt.
Shell is not so fortunate as is yet to finish a huge $25 billion buyback programme it launched in the middle of 2018. A $15 billion dent has been made in that figure so far, but Shell had originally said it intended to return the remaining $10 billion-or-so to investors before the end of 2020. But with cash flow struggling to cover all its costs, it said it would only repurchase $1 billion worth of shares before late April 2020, down from $2.8 billion in the final quarter of 2019. This has prompted fears that Shell won’t be able to sustainably afford to complete the buyback programme this year while servicing debt and funding investment if oil prices remain low, reinforced by the fact that its dividend for the year was kept flat too. It returned nearly $10.2 billion through buybacks in 2019 overall, and there are fears over whether it can return a similar amount in 2020 as planned.
In a nutshell, BP looks more capable of covering all its expenditure and investment, service its debt and pay dividends (partly thanks to the end of its buyback programme) than Shell does. Plus, BP needs a lower oil price to break even than Shell in 2020, which should make it more resilient this year if prices remain low as expected. This means returns from BP look safe while Shell’s are deemed more at risk.
What is the outlook for oil prices?
There are several headwinds putting pressure on the price of oil in early 2020, and the majority of analysts believe they will remain under pressure. As of 4 February, Brent was trading at $55 per barrel while WTI was at $51. Some believe there is room for improvement this year, such as the International Energy Agency that predicts Brent will average $65 per barrel in 2020. Others are more conservative, like Citigroup, which believes Brent could fall to as low as $47 per barrel.
There are several reasons why oil has been under pressure, including increased supply at a time when demand has softened because of geopolitical tensions. These include the trade war between the US and China – which are the two biggest consumers of oil in the world. More recently, the outbreak of a new coronavirus has prompted fears that demand for oil will take a beating in the coming months as the economic fallout becomes clear, particularly in the epicentre of China. Reduced travel, consumer demand and industrial activity will all decrease demand for oil from China and weigh on global prices. BP’s outgoing chief financial officer (CFO), Brian Gilvary, warned that the coronavirus alone could knock 0.5% off oil demand in 2020.
With this in mind, there is justification in the fears of Shell shareholders considering the oil major has said it needs an average oil price of around $66 per barrel to break even, whereas BP’s is thought to be closer to $50 (although this was not confirmed in BP’s latest results).
Read more: How to trade oil
Where next for BP?
The release of its 2019 results marks a new era for BP as it says goodbye to its chief executive officer (CEO) Bob Dudley and its CFO Brian Gilvary, both of whom have earned a solid reputation after helping BP recover from the Deepwater Horizon oil spill in 2010. Bernard Looney, who heads the company’s upstream business, will take over as CEO, while Murray Auchincloss, the CFO of the upstream unit, will take over from Gilvary.
Dudley and Gilvary leave on a high, having raised the dividend and kept BP on sound financial footing as they depart. The dividend was raised and cash flow comfortably covered the payout plus all of its other costs. In addition, some of the largest components of its expenditure are tailing off, which will give BP more wiggle room if oil prices remain low going forward. For example, the end of the scrip dividend programme will free up some major cash this year considering it repurchased $1.5 billion worth of stock in 2019. Plus, while BP has paid over $65 billion overall for the 2010 oil spill, payments are tailing off. BP expects to pay less than $1 billion in 2020 compared to the $2.4 billion paid in 2019.
BP said it is confident it can deliver its cash flow targets by 2021, suggesting it can comfortably cover its expenditure and payouts over the coming years. The fact it has ramped up divestments in order to raise cash so debt can be reduced is a bonus as this will provide it with further firepower. BP has said it intended to sell off $10 billion worth of assets before the end of 2020, but has practically hit that goal already, having offloaded $9.4 billion of operations so far. As a result, it has said it intends to sell an additional $5 billion of assets by ‘mid-2021’. Notably, it has denied reports that it is contemplating a divestment from its 19.75% stake in Russian outfit Rosneft, which is reported to be worth somewhere in the region of $15 billion.
The faster-than-expected asset sales helped lower net debt last year, and while gearing remains high – sitting at 31.1% - BP believes it is more than capable of bringing this down ‘towards the middle of the 20% to 30% range through this year’.
‘We continue to make strong progress on our divestment programme, with announced transactions totalling $9.4 billion since the start of 2019. We are ahead of our target of $10 billion of proceeds by end-2020, and now plan a further $5 billion of agreed disposals by mid-2021. Net debt fell $1 billion in Q4, and with further disposal proceeds expected, and assuming recent average oil prices, we continue to expect gearing to move towards the middle of the 20 to 30% range through this year. Together with the continued strong operational momentum, growing free cash flow, and our confidence in delivery of 2021 free cash flow targets, this underpins our announcement today of an increase in the dividend to 10.5 cents per ordinary share,’ said Gilvary in his last event as the CFO of BP.
Where next for Shell?
The short-term outlook for Shell looks less certain, with investors worried that returns will slow and that the share buyback programme won’t be completed on time by the end of this year. Although Shell remains committed to the programme, it has warned that it isn’t its main priority.
‘We remain committed to prudent capital discipline supported by world-class project delivery and are looking to further strengthen our balance sheet while we continue with share buybacks. Our intention to complete the $25 billion share buyback programme is unchanged, but the pace remains subject to macro conditions and further debt reduction,' said CEO Ben van Beurden.
It is clear that Shell needs considerably higher oil prices if it is to please everyone. Shell generated $42.2 billion in operating cash flow and $26.4 billion in free cash flow last year, but budgeted $23 billion on capex, paid out $15 billion in dividends and $10 billion on buybacks – and it has to pay back its debt on top of that. With this in mind, it is clear why some investors fear shareholder returns could be sacrificed in favour of debt and investment if oil prices remain low. CEO van Beurden has warned that Shell’s cash flow could fall by as much as $7 billion between mid-2019 and the end of 2020 if the current global economic backdrop persists.
Simply put – Shell needs higher oil prices to afford to do everything it wants. But, if that doesn’t happen, then something will have to give, and Shell has already made it clear that shareholder returns will take a back seat if they must.
This means Shell’s divestment programme will continue to be crucial if the company is to raise the cash it needs to plug any shortfalls and keep a lid on debt. Shell completed a $30 billion divestment programme between 2016 and 2018 following the huge BG acquisition, but has said it intends to offload a further $10 billion worth of assets in 2020.
Shell has long been one of the best performers in the global oil and gas sector but is facing some short-term pressure because of its inability to generate the cash it needs at current oil prices. It only has so many levers to pull, and, unfortunately for investors, it is their returns that could be sacrificed.
Broker ratings: BP vs Shell
Brokers are extremely bullish on both oil companies in the long term, with BP and Shell each boasting a Buy rating. The average target price among the 24 brokers covering BP sits at £6 per share – one-third higher than its current share price of 465.9p (as of 1500 GMT on 4 February). The potential upside for Shell shares is even greater, with an average target price of £28.2688 implying Shell shares could grow by as much as 44%.
Source: Thomson Reuters
How to trade BP and Shell shares
- Research the companies and decide if you’re interested in BP shares or Shell shares – or both
- Decide whether you'd like to buy the shares or trade them
- Open an account
- Place your trade
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