finance report

Table of Contents

Introduction ............................................................................................................................................ Finance Analysis......................................................................................................................................3 Profitability ratios ............................................................................................................................... 3 ROCE................................................................................................................................................ 3 Net Profit Margin ............................................................................................................................ 4 Efficiency ratios...................................................................................................................................4 Receivable Turnover ....................................................................................................................... 4 Payable Turnover ............................................................................................................................ 5 Gearing/ Financial Risk ratios.............................................................................................................. 6 Gearing ratios.................................................................................................................................. 6 Cash Interest Cover.........................................................................................................................7 Liquidity ratios .................................................................................................................................... 7 Current Ratio...................................................................................................................................7 Operating Cash Flow to Current Liabilities ..................................................................................... 8 Investor Ratios .................................................................................................................................... 9 Dividend per share..........................................................................................................................9 Dividend Cover..............................................................................................................................10 Conclusion............................................................................................................................................. 1 References . Appendices...................................................................................................................................... Appendix 1 ........................................................................................................................................ Appendix 2 ........................................................................................................................................ Appendix 3 ........................................................................................................................................

Introduction

In this report I will examine the performance of one of the top oil and gas producers; Royal Dutch Shell PLC. The selected ratios will be calculated (see app. 2) and compared with other leaders in this industry, such as Exxon Mobil, British Petroleum (BP), Chevron Corp. and Sinopec. This will provide an understanding of the company’s profitability, financial risk, earnings and their cash flows over past 5 years using company’s financial statements (see app.1). By comparing Royal Dutch Shell with other industry (see app.3) leaders the report hopes to provide a balanced and transparent overview of the aforementioned ratios. This ratio analysis and benchmarking will give us an informed insight into whether or not to acquire the Royal Dutch Shell as a profitable and reliable investment in the future.

Finance Analysis

Profitability ratios

‘Profitability ratios indicate how successful the managers of a company have been in generating profit’ (Watson and Head, p.48, 2010). Here we will be looking at Royal Dutch Shell Return on Capital Employed (ROCE) and Net Profit Margin known also as Operating Profit Margin ratios (calculations can be seen in app.2) over past 5 years.

ROCE is easy to calculate and interpreted as results are in percent. Therefore it is easy to compare with different companies. This ratio looks at the company’s overall profitability.

Royal Dutch Shell has had a healthy increase in ROCE; from 15.9% in 2010 to a peak of 22.9% over the 5 year period, as shown in the above graph in 2011. This sharp increase could be due to company’s strong performances and their share price increase. Industry average in this time scale is also following the lead of growth ROCE between 2010 and 2011.

Starting from 2011 onwards there is a decrease in ROCE. This is due to generally weaker oil prices.

‘Royal Dutch Shell Plc, Europe’s biggest oil company, reported a larger decline than expected in second-quarter earnings as crude prices dropped and maintenance work on fields held back production’ (Gismatullin and Lacqua , 2012).

The oil industries average decrease is more even than that reported by Shell. Shell’s ROCE is steadily above industries average, only in 2013 it fell under industries average by 12.7%, where the overall industry average was 13.76%.

Net Profit Margin is shown as percentage. This ratio measures how much the company earns per each dollar spent.

In 2010 Shell had an income of 9.6 cents per every dollar they spent, where industry average earned 7.74 cents per every dollar spent. Shell reached a peak high in 2011 with 11.8 percent with the industry average just 1.52% below that.

‘Shell also said it had sold $4bn of non-core assets in the first six months of the year, which was a "key driver" to reducing costs and improving its operating performance’ (bbc.co.uk, 2011).

Efficiency ratios

Receivable Turnover

Receivable turnover ratio monitors how well the company deals with their receivables.

‘The lower the amount of uncollected monies from its operations, the higher this ratio will be. In contrast, if a company has more of its revenues awaiting receipt, the lower the ratio will be’ (financeformulas.net, 2012).

This ratio is also known as debtor’s turnover ratio. This looks at companies’ ability to issue credit and collect the debt in sensible time.

In 2010 Shell had a record high account receivable turnover, collecting payment from customers every 986 days. However, this data seems unrealistic; with the average payment schedules usually amounting to between 19 and 21 payments annually. One could argue this anomaly a possible mistake in the account receivable data (see app. 1).

‘A very high accounts receivable turnover number can indicate an excessively restrictive credit policy, where the credit manager is only allowing credit sales to the most credit-worthy customers, and letting competitors with looser credit policies take away other sales’ (accountingtools.com, 2016).

Due to this high number of receivables, industry average was significantly influenced. For the following 4 years there is a more reasonable time for accounting receivable turnover which is between 11 and 18 days. Where industries average are between 19 and 21 day.

Payable Turnover

‘The accounts payable turnover ratio indicates how many times a company pays off its suppliers during an accounting period’ (thestrategiccfo.com, 2015).

According to the payable turnover Shell pays their payables only twice a year; in 2010, 2011 and 2013. In 2012 Shell received payables only once a year. In 2014 they made their payments 4 times in a year. Where industry averages pays their payables as many as 26 times a year.

Gearing/ Financial Risk ratios

Gearing ratios look at debt and equity proportions in the company. Financial leverage or capital structure looks at the mix and utilization of equity and debt capital. Royal Dutch Shell adapt the traditional capital structure approach. This particular approach lends faith to an optimal capital structure. ‘This approach very clearly implies that the cost of capital decreases within the reasonable limit of debt and then increases with average’ (Chand, 2015).

Shell keeps their gearing ratio under 50% which helps them to reduce capital costs. Their highest gearing appeared in 2010 with 29.5%. In 2010 the Shell may have needed to use more debt financing due to high investments in explorations, plants etc. Industry average highest gearing usage was in 2014 with 27.13%.

The company main objective should be shareholder wealth maximisation. They then should keep the costs down to increase the revenues, which all 5 companies are doing by keeping gearing under the 50% mark.

Shell have a very high coverage for cash interest cover compared to industries average. This could mean that they have a high number of cash unused sitting in the bank, which could be reinvested back into the company or payed out as a dividends. Royal Dutch Shell and Exxon Mobil should consider their opportunity costs related to this cash. The rest of industries taken into account for this average have a reasonable amount of interest cover, using the available money for better use.

Liquidity ratios

Current Ratio measures the ability to pay its debt over the 12 month period. This ratio shows how much protection they have over each $1 borrowed.

The Current Ratio shows that the debt level of Royal Dutch Shell is balanced and desirable for investors. The above graph shows that Shell PLC has between1.1:1 and 1.2:1 ratios for debt cover. This protection stays steady over the 5 year period, even though the company’s revenue changes over these years, the debt is protected. However, as these ratios are based on the balance sheet in the financial statement this data can be manipulated for the company’s personal gain.

Operating Cash Flow to Current Liabilities

‘Current liabilities are paid with cash so this ratio allows us to tell if a business is generating enough cash from operations to meet these liabilities’ (accofina.com, 2013). If the operating cash flow to current liabilities ratio is under 1 it means that they do not have generated cash to pay off short term liabilities. It is interesting that both Shell and the industry average do not have enough cash over this 5 year period, especially as all these 5 oil and gas companies are considered as leaders in their field of business. This cash could have been re-invested back into the company or have been tied up somewhere else. The above graph shows that industries and Royal Dutch Shells cash flows are improving gradually over the years and becoming healthier.

Investor Ratios

Dividend per share is the total dividend paid for the share over the year, it can be made as one or two payments. The above graph shows that dividends for Royal Dutch Shells shareholders have been growing slowly but with a steady pace. Royal Dutch Shells dividend policy is to; ‘grow the US dollar dividend in line with our view of the underlying earnings and cash flow of Shell’ (Shell.com, 2016).

Even though Shells revenue has decreased in 2012, 2013 and 2014 their dividend per share has had a steady increase to keep their shareholders pleased. Stable dividend policy is favourable in the shareholder view as they know their dividend is going to increase every year.

Industry average also has a steady increase in dividend payments over these 5 years. Steady growth in dividend payments send a positive signal to their existing and potential shareholders.

In 2011 Shell had a massive increase in revenue but they decided not to increase dividends and kept them the same as in 2011. ‘In 2010, the company spent some 1.02 billion U.S. dollars on R&D’ (statista.com, 2016).

Dividend Cover

Dividend Cover shows how many times the company can cover dividend payments. Dividend cover of less than 1.5 is viewed as a threat to shareholders as this may impact their dividend payments significantly. More than 2 times is viewed as strong.

Industry average is steadily above 2 in all 5 years consecutively, which is a good signal for potential investors. Royal Dutch Shell have had ups and downs on their dividend coverage but still they kept a steady increase on their dividend payments each year. Industry average

also has a steady and very strong dividend cover, even though with each year the coverage declines. ‘Investors use dividend cover ratio to gauge the level of risk associated with the receipt of dividends on their investment’ (accounting-simplified.com, 2013). As the Royal Dutch Shell’s dividend cover is under 1.50 for 2013 and 2014 this may suggest that the company will not be able to cover dividend payment in the case of profitability falling in the future and this may affect share valuation.

Conclusion

In summary by looking at Royal Dutch Shell PLC’s annual report and financial statements for the previous 5 year period from 2014 - 2010 we were able to draw conclusions concerning profitability, financial risk, efficiency, liquidity and investment, and comparing them with industry averages including; Sinopec, Exxon Mobil, British Petroleum and Chevron Corporation.

Given the information examined, I would not give the recommendation to acquire the Royal Dutch Shell. Even though it is the largest oil and gas company in Europe, with healthy revenues and steady dividend payment increases, all the major ratios examined in the report showed a steady decrease beginning at 2011 onwards. This may be due to the Middle East financial crisis which led to a massive oil price drop per barrel and the current drive for sustainable energy. I would advise to further analyse the most recent financial statements of Royal Dutch Shell, as the significant research and development investment of the company could lead to alternative energy sources in the future.