2024-01-18 11:33:12 ET
Summary
- Shell is refocusing its business on core assets and exiting ancillary projects in order to simplify their business model.
- The company is focusing on offshore projects, with production commencing at the FPSO Sepetiba and further investing in surrounding blocks in the Sparta development, which should commence production in 2028.
- Management anticipates an FCF run rate of 6% growth through 2030 and eluded to a CFFO payout ratio of 30-40% in the form of buybacks and dividends.
Shell ( SHEL ) has been making strides in refocusing its business away from ancillary projects and more into its core assets. Shell updated their Q4’23 guidance on January 7, 2024, and provided a narrower focus on what to expect as the fiscal year comes to a close. Going into 2024, market expectations remain relatively flat for Brent and natural gas with the expectation of a continued downcycle for petrochemicals. Though I believe management is taking the right steps to refocus operations across their core assets, I believe much of the value for FY24 will be the result of shareholder benefits, such as dividends and share buybacks. With this, I provide SHEL a HOLD recommendation with a price target of $70.40/share at 5.75x eFY24 EV/EBITDA.
Operations
Shell has been refocusing the firm and exiting some overseas ventures in order to bolster their core business. This includes exiting the two offshore production sharing contracts in Malaysia’s Baram Delta , the sale of its 35% participating interest in Indonesia’s Masela block, the sale of 51.8% interest in Aera Energy , and the sale of their onshore business in Nigeria . On the flip side, Shell has been focusing more heavily on their offshore projects, with production of the FPSO Sepetiba commencing at their offshore Santos Basin at the end of December 2023 as well as further investments in the Sparta development in the Gulf of Mexico assets. Overall, Shell is planning to allocate $1b per year for exploration with a core focus in Brazil, Namibia, and the Gulf of Mexico for greenfield projects.
According to S&P Global , Shell isn’t the only IOC with strong interest in the Gulf of Mexico. The recent US Gulf Lease Sale 261 experienced high bids of $382.2mm , the largest amount in eight years, with Occidental Petroleum ( OXY ) taking one of the largest bids at $25.5mm for the Mississippi Canyon 389 block. Shell came out with 65 blocks for $69mm in high bids in the auction, spending $6.9mm for a Garden Banks block and $5.3mm for a Keathley Canyon tract. The Garden Banks block Shell purchased leases for is said to be relatively close to their Sparta development. Sparta is expected to commence production in 2028 and is estimated to produce 90Mboe/d with 244MMboe in recoverable resources. In the near-term, management anticipates having 500Mbbl/d of new production coming online by 2025.
The development of the Sparta project is one of the initiatives Shell is focused on in which the project is replicating their Vito and Whale designs, which are 4-column semisubmersible floaters. The initiative is to create a more modular replicable blueprint for future developments. I believe that this should reduce future capital investment requirements per project.
In addition to these developments, the LNG Canada project has surpassed the 85% completion threshold and is expected to commence operations sometime in 2024 . This 14mtpa facility , with the option to double its capacity in the future, is conveniently located on the West Coast of British Columbia and will potentially be supplied by Alberta, Canada-based producers in the developing Montney Basin. Given the geography and equity partners in this facility, I anticipate a significant proportion of the gas will be shipped to China and surrounding Asian countries.
Financials
Shell experienced a strong Q3’23 as margins expanded despite a slight decline in revenue growth resulting from a challenging commodities market and business divestitures. I believe Shell should have the capacity to continue expanding their margins as the firm focuses on long-cycle production.
For the upstream business, Shell anticipates to produce 1,830-1,930Mboe/d in Q4’23, a 3-9% sequential increase in production volumes. Assuming $85/bbl average Brent and ballpark $6.65/mcf of gas, I anticipate upstream to generate $6,346-6,692mm in aEBITDA for Q4’23.
Within their integrated gas segment, LNG sales for FY23 is expected to lag the previous year by just over 1mtpa, possibly the result of their exit from their Gazprom entity in FY22 and the dispute with Venture Global. Shell should experience tailwinds in Q1’24 relating to wrapping up the maintenance turnaround at their Prelude facility offshore Australia . In addition to this, LNG capacity is anticipated to pick up sometime within the next year or so as the LNG Canada facility’s operations commence. Longer term, management anticipates to have 11mtpa in LNG export capacity by 2030.
On a broader macro perspective, I anticipate chemicals to continue on its cyclical downcycle as global supply outpaces demand. Both Wood Mackenzie and ICIS suggest that there could be some M&A in the petrochemicals space, which could be good for Shell as they exit some overseas operations. Despite the downcycle, management did indicate sequential improvement in chemicals margins from $115/tonne in Q3’23 to $125/tonne in eQ4’23.
As for marketing, a Bloomberg article suggested that Shell may experience strength in gas trading during the soft oil and chemicals market. Though a lower margin business, this could add some stability at the top line. One last challenge faced is the matter of the drone strikes in the Red Sea. Shell recently joined others in the industry and has made the decision to bypass the Red Sea and reduce the risk of a targeted attack and a spill.
In total, management anticipates a run rate of 10% FCF/share through 2025 and absolute free cash flow growth of 6% from now through 2030. If this remains the case, Shell should generate $19b in free cash flow at the suggested 6% growth rate in Q4’23 for total FY23 FCF of $48.7b.
Valuation and Shareholder Value
Since departing from under the Dutch government in 2021, Shell has made strides in offering competitive shareholder benefits including a 4% annualized dividend yield and the $3.5b buyback program throughout Q4’23. Though management opted not to discuss 2024 guidance on operations or shareholder benefits, they did discern that the firm will return 30-40% of CFFO going forward. With the expected run rate of 6% in free cash flow growth, we can expect ballpark $22-$30b in shareholder returns in eFY24 on the back of $75b in CFFO. I would expect management to maintain slow and steady dividend growth while bolstering buybacks in order to manage a steady dividend rate increase given the industry’s cyclicality. Considering FY23’s breakdown, I believe that this could be in proximity of 60/40 buybacks/dividends.
Looking at peer comps, SHEL's stock trades at the lower end of the range for foreign IOCs and more in line with the two domestic majors, Exxon ( XOM ) and Chevron ( CVX ). Split down the middle, the average EV/EBITDA multiple comes out to 7.22x, valuing SHEL at $79.55/share.
From a macro perspective, I believe 2024 will be a flat market for the price of oil with Brent prices floating around the high-$70-$85 /bbl paired with modest tailwinds in natural gas . It is hard to say when the downcycle for chemicals will turn around; however, given the global economic slowdown, the downcycle may continue through 2024. Though there may be more value that can be extracted out of SHEL shares, I believe much of the value in 2024 will be the result of buybacks and dividends. With that, I provide SHEL a HOLD recommendation with a price target of $70.40/share based on 5.75x eFY24 EV/EBITDA with EBITDA at $88b.
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Shell Is Refocusing The Future Of The Firm