Shell’s (RDSB) third-quarter earnings report and conference call yesterday disappointed investors on a variety of fronts, and have led to shares selling off sharply, just as they did three months ago in response to last quarter’s results. Yesterday’s disappointments were widespread - the fourth quarter was guided to be weak, and 
Shell’s recent spending splurge on Repsol’s LNG assets and stake in Brazilian oilfields (Libra and BC-10) will force the company to divest as much as $15 billion in assets, creating concerns about its free cash flow outlook. Further, exploration results also have been disappointing thus far in 2013, as evidenced by a $900 million write-off this quarter. The only silver lining we see is that the negatives yesterday do not affect Shell’s long-term operating prospects. Accordingly, we are maintaining our fair value and moat ratings.
Shell today is facing a credibility problem in the market: our sense is that management has let the problems in its shale portfolio and downstream fester for so long that the market concerns have moved beyond these areas to include the company’s overall capital efficiency and execution. There’s no question that management and the board have been painfully slow in addressing the company’s key weaknesses. Even though some actions are now being taken - shale acreage is being divested, shale rigs have been taken offline, a few refineries will be divested, etc. - we still are concerned with how long it took for these decisions to be made. We can’t help but feel the best run large-cap oil companies would have recognized these operational weaknesses far earlier and acted much more rapidly to address them.
Given all of the operational and portfolio issues of late, we believe market consensus today is that Shell’s unimpressive capital efficiency and execution will continue for the foreseeable future. Were this to be the wrong assessment and Shell make some bold strokes to improve its business, its stock could easily outperform its peer group in the coming years. Unfortunately, we just don’t see anything to support the idea that management and the board are in a hurry. Operationally, Shell appears likely to remain at the bottom of the pack for some time to come.
With respect to Shell’s cash flow outlook, we don’t see the recent developments as overly concerning. The high capital spending bill this year ($46 billion, including $10 in acquisitions) simply means Shell has less to spend in 2014-15 and will sell a few billion dollars more of assets than the market had expected. None of this changes the cash flow outlook we’ve had for some time: with oil prices at or near $100 per barrel, Shell is positioned to continue increasing its dividend at modest (i.e. single-digit rates) during the next few years.
