Shell

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 3/5

Shell plc is a global group of energy and petrochemical companies, primarily involved in exploration, production, refining, and marketing of oil, natural gas, and renewable energy solutions, with operations in more than 70 countries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The company’s primary objective is to “Powering Progress”, which aims to deliver more and cleaner energy solutions for a growing world while generating value for shareholders and wider society.

Business Overview & Moat Analysis:

Shell’s operations are broadly categorized into three main segments:

  • Integrated Gas: This segment explores and produces natural gas, including liquefied natural gas (LNG), and engages in marketing and trading activities. It accounts for a substantial portion of Shell’s production volume.
  • Upstream: This segment is focused on exploration and production of crude oil, natural gas and natural gas liquids (NGL) and includes production from integrated and conventional oil and gas activities.
  • Downstream, Renewables, and Energy Solutions: This segment refines crude oil into petroleum products; manufactures, markets and distributes chemical products; and develops low-carbon energy solutions, including renewable power and carbon capture.

Moat Assessment: 3/5 While Shell doesn’t possess a “wide” moat in the traditional sense, it does exhibit characteristics of a “narrow” moat due to certain competitive advantages.

  • Scale and Integration: Shell is one of the world’s largest integrated oil and gas companies, which gives it economies of scale in multiple segments. Its ability to refine and market its production enhances its control over the value chain, reducing costs, improving efficiency, and creating opportunities to capture added value. * Resource Access: Access to high-quality and diverse oil and gas reserves around the world provides Shell with an advantage over other companies. This advantage, however, is limited by increasing competition and the uncertainty related to demand for oil and gas. * Switching Costs: While it may not be as noticeable as tech, switching costs in some of the company’s product segments and services can provide a narrow moat. Businesses such as commercial marine and aviation face switching costs due to the logistical and security concerns of switching energy suppliers. * Brand Strength: Although not a dominant factor across the industry, brand recognition, especially in fuels like Shell V-Power, creates a preference among customers. Brand alone, however, is not usually a strong source of a competitive advantage for energy businesses.

  • Technology and Innovation: While Shell invests heavily in research and development (R&D), technology is seldom a very effective differentiator in this industry.

  • Overall: Shell doesn’t posses strong enough and long lasting competitive advantage to generate high return on capital or a level where a moat is considered wide. The company is too big to create large inefficiencies but too small to get unique resource advantages.

In summary, though Shell has competitive advantages, these are not necessarily that long lasting and not as meaningful to guarantee long-term profitability.

Risks to the Moat and Business Resilience:

Shell faces several risks that could threaten its moat and business resilience:

  • Transition to Renewable Energy: The increasing global push for renewable energy sources is a major risk for the oil and gas industry. While Shell is investing in lower carbon solutions, the rate at which the transition moves forward remains uncertain. Government policies, taxes, and regulations can further hurt the fossil fuel industries.
  • Price Volatility: Prices of oil and gas are notoriously volatile and can quickly change. This factor is mostly driven by the supply/demand imbalance due to macro-economic conditions or geopolitical factors, or unforeseen natural events like hurricanes and weather.
  • Geopolitical Risks: Shell operates in more than 70 countries which introduces a wide range of political, legal and financial stability. Changes in such markets can materially affect business operations and profitability.
  • Technological Disruption: As technologies shift in the oil and energy market, companies need to move fast to keep up or lose market share and profitability.

Despite these risks, Shell demonstrates certain resilience:

  • Integration and Diversification: Shell’s large size and diverse portfolio of businesses provide a buffer against volatility in any particular segment of the market.
  • Financial Strength: The company possesses sufficient cash to navigate a highly cyclical business, or an economic downturn, while still being able to execute growth and restructuring plans.
  • Established presence: As a large multinational company, Shell has an extensive network and a proven track record.

Financial Analysis:

Shell’s financials are highly influenced by volatile oil and gas prices, so this analysis only provides a snapshot of the company’s financial health.

  • Revenue Distribution (2023): Integrated Gas: $58.5 billion in revenue Upstream: $132.2 billion in revenue Downstream, Renewables, and Energy Solutions: $177.4 billion
  • Earnings:
    • The overall earnings fell significantly in 2023 in part due to global supply/demand imbalances, inflation, and the Russian-Ukraine war, leading to a drop in profits from an average of $21-$23 billion per quarter in 2022 to $13.95 billion during the first 3 quarters of 2023. The company posted a profit of $7.5 billion in the fourth quarter, up 57% from last year but still lower than what was seen in 2022.

  • The adjusted EBITDA increased slightly to $27.87 billion in 2023 due to improved upstream margins.

  • Margins:
    • In 2023, the upstream business was more profitable, where Shell benefited from lower taxes and higher margins due to cost reductions. The Downstream segment experienced lower margins due to a reduction in the refining capacity.

  • Overall EBITDA margin remained relatively flat at around 9-10% in recent years.

  • Capital Expenditures: Capital spending is significant for this company. In 2023 they spent around $24.8 billion. This included investment in renewable energy projects, as well as exploration and development in oil and gas.
  • Capital Allocation and Shareholder Returns Shell aims for a long-term payout ratio of 30-40%, by combining dividends and repurchases. Their plan is to also deliver shareholder returns through organic growth.

Balance Sheet Health: 3/5

Shell’s balance sheet shows an adequate, if declining, level of health, which has also become more volatile in the past couple of years due to higher risk and large swings in the market. Some key takeaways are:

  • Debt Levels: The company has used high oil prices to pay back some debt, reducing leverage and improving its rating with debt rating agencies.
  • Cash Position: Shell holds cash and cash equivalents of $30.9 billion as of December 2023. This is mostly in liquid assets that can be readily deployed to business operations, reducing financial distress.
  • Goodwill: Shell’s goodwill and intangible assets is around $38 billion, which is in the high range, and requires careful monitoring.
  • Overall: While the company has strong financials, debt is still higher than the levels that provide a solid “safe” position, and goodwill is also relatively high.

Understandability: 4/5 While the energy sector can be somewhat complex, Shell’s business model is easy to understand. The company’s operations are based on a fairly straightforward supply chain, and its financial reports are generally transparent. The details of the balance sheets, income statements, and cash flows, however, are not always easy to analyze and understand.

Controversies and Concerns

Shell has faced numerous controversies and challenges:

  • Climate Change: Shell is continually pressured by investors and the public for its environmental impact. This is also the biggest risk to their business model and profitability in the long run. To counter that, the company is investing in new lower carbon technologies and is planning on transitioning to renewable energy, while continuing operations in oil and gas for the moment. Shell was in 2022 forced to revise their emissions targets after a Dutch court ordered them to significantly cut emissions. The new plan set a 2030 target of reducing emissions to 50% of 2016 levels, down from a previous 20% target.
  • Operational issues: Problems in operation have hurt its reputation as a well run company, the most recent example being their issues with the Prelude facility and associated write downs. Also, recent findings of human rights issues at a Shell Nigeria facility could have a material impact on the company.
  • Profitability Issues in Refining: Overcapacity, and low refining margins, negatively impact the company profitability as a whole.

  • Geopolitical Instability: Russia and Ukraine conflicts, and other factors, have significantly contributed to extreme volatility in the prices of oil and gas.

    • Management Views

Shell is well aware of the criticism against fossil fuel industry, especially with regard to the climate. Their strategy for the future is to become a net zero emissions business by 2050, by also delivering value for shareholders. The management is currently actively exploring new opportunities in this space. Management has also reiterated that production from existing oil and gas fields will remain for years in order to meet demand for the same.

They also highlight how their company is investing in biofuels, hydrogen, carbon capture, electric vehicle charging, and low-carbon solutions to help the transition.

Management also highlights the structural nature of the energy industry, which creates opportunity for companies like Shell to generate returns, while the energy transition occurs. They also point out the benefits of economies of scale and integration, enabling high profit margins.

The company stresses the importance of a culture of safety and responsibility, with investments aimed at protecting both people and the planet.
  • The management highlights the company’s strategic priority of maintaining disciplined capital allocation. They point out how they managed to achieve $43 billion in cash flow from operations, while keeping the dividend payout unchanged. They aim for long-term profitability by maintaining a target gearing level in the low-teens.

In summary, Shell has competitive advantages that provide a narrow moat, making it a fairly well positioned investment. However, several risks could pose a threat to the long-term value creation of the company and require diligent monitoring. The volatile and cyclical nature of the company can also be difficult to deal with and could impact performance from time to time.