Royal Dutch Shell - Case Study Example

Table of Contents Introduction 1 Profitability ratios 2 Return on Capital Employed 2 Net profit margin 4 Efficiency Ratios 4 Account receivables turnover 5 Account Payables Turnover 6 Gearing ratios 7 Gearing 7 Interest Cover 8 Liquidity Ratios 10 Current Ratio 10 Operating Cashflows to current liabilities 10 Investors Ratio 11 Dividend per share 11 Dividend Cover 13 Conclusion 14 Appendix 17 Introduction This report has been prepared to examine the financial performance of Royal Dutch Shell Company which is considered a top oil and gas producers globally. In this regard, various ratios have been selected to examine the company’s profitability, liquidity, leverage, efficiency and suitability for investment over a five years period from 2012 to 2016. The ratios are then compared to the industry performance and that of the company’s competitors such as Total SA, Exxon Mobil, Chevron Corp. and British Petroleum. By so doing, it is hoped that the report does provide a balanced and transparent view of the company’s financial performance hence giving a good insight as to whether or not to invest in the company. Arising from the analysis, the report does not recommend investing in the company as it is considered to have performed poorly over the five year period in comparison to the company while its performance has consistently declined over the period. Profitability ratios These are ratios that are used in assessing the business’s ability of generating earnings compared to its expenses and related costs incurred during an accounting period. Having a higher ratio relative to the industry or competitors will be an indication that the company is performing well. In the case of Royal Dutch Shell, return on capital employed and net profit margin will be compared with industry performance. Return on Capital Employed Return on capital employed is calculated by dividing the company’s earnings before tax with the capital employed. The ratio measures the company’s profitability and the efficiency at which it utilizes its capital employed to generate profit. A higher ratio is preferred as it is an indication of more efficient use of capital. Royal Dutch Shell’s ROCE has consistently declined over the five years period from a high of 19.94% in 2012 to a low of 1.66 in 2016 as depicted in the graph below. The decline is not synonymous with the company since a similar trend has been observed for the industry. The industry average was 19.14% in 2012 and this has consistently lowered to 0.7 in 2016. The sharp decline is attributed to the conditions in the operating environment as commodity prices continued to decline over the same period. Royal Dutch Shell became the latest big energy company to file a damage report on the impact of depressed oil prices, saying on Thursday that its adjusted profit fell 56 percent in the fourth quarter of 2015 compared to a year earlier (Reed, 2016) The decline in the industry is in fact greater than that of the company and the industry only performed better than the company in 2013 and 2015. As such, it could be argued that the company’s ROCE was better than that of the industry over the five years period. Net profit margin This ratio measures the percentage returns that the company gets out of every dollar of its revenue. Just like ROCE, the company’s net profit margin has consistently declined over the five years period. The net profit margin for the company was the highest in 2012 when it was 10.81 percent and the lowest in 2015 when it was 0.77 percent. This compares well with the industry performance which was the highest in 2012 at 13.01 percent and the lowest in 2016 when it was 1.52 percent. However, overall the company performed worse than the industry over the period only performing better than the industry in 2016. Efficiency Ratios The ratios measure the company’s ability of using its assets and managing liabilities efficiently. Account receivables turnover This ratio assesses how efficient the company is in managing its receivables. The lower the amount of uncollected monies from its operations, the higher the ratio will be. In contrast, if a company has more of its revenues awaiting receipt, the lower the ratio will be (Financeformulas.net, 2012) The lower the number of days the company takes to collect its debts, the more efficient the company is. In addition, if the company takes less time to collect its debts compared to the industry, it is considered better. The company’s accounts receivables turnover and hence efficiency in debt collection has had a declining trend over the five years period. In 2012, it was 59 days before slightly lowering to 58 days in 2014. However, it rose sharply from 2014 to 87 days in 2016. The performance does compare with the industry performance which was also lowest in 2014 at 33.8 days and the highest in 2016 at 50.6 days. While the declining performance could be attributed to prevailing conditions in the industry, Royal Dutch Shell’s accounts receivables ratio is far much higher than that of the industry meaning that it takes longer than the industry in collecting its debts. According to Mohr (2017), this may indicate that the company has a poorer collecting process and a bad credit policy compared to its competitors. Thus, it can be concluded that the company is not performing well in collecting its debts. Account Payables Turnover This ratio gives an indication of how fast the company is in paying off its suppliers over an accounting period. The company took 71 days to pay off its debtors in 2012 and this has deteriorated to 116 days in 2016. This however compares well with the industry average which was 49.4 days in 2012 at the lowest and it was the highest in 2016 when on average, companies in the industry took 95.4 days to pay off its suppliers. The worse performance by the company is not preferable as it might be an indication that the company finds problems in paying off its suppliers which has the potential to affect its operations in future. Gearing ratios Gearing This ratio looks at the proportion of the company’s debt relative to its equity. In other words, how much cents or dollars of debt does the company has for every dollar of equity (Chand, 2015). The ratio thus is concerned with the mix and utilization of debt and equity capital. Royal Dutch Shell has adopted an aggressive capital structure that seems to favor increased debt as opposed to equity. The capital structure may be preferable since the cost of debt is usually lower than the cost of capital. However, this indicates an increased risk to the investors and hence increased leverage risk to the company given the declining profitability (Investopedia.com, 2017). The company’s debt has consistently greater than equity with the exception of 2013 when it was 97.34 percent of equity. It was the highest in 2016 at 118.17% of equity. This does compare well with the industry whose averages have consistently increased from a low of 96.19 percent in 2012 to 116.82 percent in 2016. While the increased appetite may be attributed to increasing investments, it is majorly linked to the declining profitability and hence the need to source for external financing due to limited internal sources. However, this may not be in line with shareholder wealth maximization since the company’s interest obligation will continue to increase and this may eat into shareholders returns causing a decline in dividends. Interest Cover The ratio shows how times the cash generated from operations may can cover the company’s interest obligations. The company has had very low interest cover over the five years period compared to its peers. It was the highest in 2012 when it was just above 30 times and the lowest in 2016 when it was just above 7 times. The industry average on the other hand was the highest in 2013 at 1014.06 times and the lowest in 2016 when it was just slightly above 28 times. The lower interest cover by the company is an indication of declining cash resources in line with declining profitability. However, a very high interest cover may also not be desirable as it may indicate that the company is not taking advantage of its idle cash resources to increase investments or pay dividends. Liquidity Ratios Current Ratio The ratio assesses the company’s ability to repay its short term debts or debts that are expiring in the current accounting period. Thus, it is an indication of whether the company will have liquidity problems that may affect its current operations. The company’s current ratio has consistently been above 1 during the five years period. It has also been stable and hence desirable ranging from a low of 1.11 in 2013 to a high of 1.32 in 2016. This is unlike the company average which has consistently declined over the period from a high of 1.27 in 2012 to a low of 1.09 in 2016. Thus, the company has performed better than the industry in this respect despite of the declining earnings (Watson and Head, 2010). Operating Cashflows to current liabilities The ratio shows the company’s ability to pay its current liabilities given that they are paid from cash and hence the company ought to generate enough operating Cashflows to meet its short-term liability obligations (Accofina.com, 2013). When this ratio is below 1, it is an indication that the company has not generated enough cash to meet its current obligations. The company’s operating Cashflows to current liabilities ratio has consistently been below 1 during the five years period with the highest level being attained in 2014 at 0.52 and the lowest level being in 2016 at 0.28. The situation is also evident as far as the industry average is concerned as the highest average was achieved in 2014 at 0.64 while the lowest was 0.32 in 2016. Overall however, the company has performed poorly compared with the industry. Investors Ratio Dividend per share This is the total amount if dividends that shareholders receive from the company over the year. From the graph, it can be seen that the company’s dividend payments have been consistent and stable over the five years period with the lowest payment of $1.71 being paid out in 2012 and the highest payment being in 2016 at $1.88. This does compare with the industry average which was the lowest in 2012 at $2.01 and the highest in 2016 at $2.40. Thus, the company seems to have adopted a dividend policy that ensures growth in dividend payment despite the earnings level (Shell.com, 2016). However, the company’s performance is far much lower than that of the industry over the period. Despite the company’s earnings consistently declining between 2012 and 2015, the dividend per share has steadily increased. This strategy is aimed at pleasing the shareholders and hence boosting their view of the company and the confidence that the return on their investments will continue increasing despite the declining commodity prices. This trend can also be observed for the industry over the five year period as depicted in the graph. The industry might have adopted such a policy with an aim of sending a positive signal to the existing and potential shareholders given the hard environment the industry has been operating in over the last few years. Dividend Cover This ratio depicts the number of times that the company is able to cover its dividend payments. Where dividend cover is less than 1.5, this is not desirable and is considered a threat to shareholders as it negatively impacts on future dividend payments significantly. A dividend cover of 2 times is considered strong and hence desirable. The company’s dividend cover was highest in 2012 at 2.5 times but this significantly declined over the years to record the lowest level at 0.16 times in 2015. This compared well with the industry performance with the best performance averaging 2.92 times in 2012 and the worst performance averaging -0.7 in 2015. The decline in dividend cover has resulted from declining earnings per share owing to declining profitability that has been caused by lowering commodity prices. However, it is good for the company to come up with corrective measures since dividend cover ratio is necessary for gauging the level of risk associated with each receipt of a divided on shareholders’ investment (accountingsimplified.com, 2013). In some instances, the company has been forced to pay dividends from retained earnings or reserves since the ratio was less than 1. This may suggest that if the profits continue on declining, the company will be unable to pay dividends in future and this may significantly affect the shares valuation and hence the company’s valuation. Conclusion The discussion above about the company’s financial performance between 2012 and 2016 relative to the industry’s performance as far as various financial ratios are concerned does reveal some insight with regard to the company’s profitability, liquidity, leverage and suitability for investment. The main Royal Dutch competitors that have been used in the comparison have included Exxon Mobil, Total SA, British Petroleum as well as Chevron Corporation. Arising from the analysis, the company has been shown to perform worse than the industry in almost all the areas examined. Although the company is considered one of the largest oil and gases companies in Europe, its revenues and profitability have consistently declined despite the steady increase in dividends. This is associated to the rapid decline in oil prices as well as increased use of sustainable energy means. Although the company’s performance does show signs of improvement in 2016, there is need to analyze the plans that the company has in future aimed at mitigating the effects of declining profitability before an investment decision can be made regarding the company. References: Royal Dutch Shell, 2015, Annual Report 2014, Retrieved on 9th May 2017, from; reports.shell.com/annual-report/2014/consolidated-financial-statements.php Royal Dutch financial statements 2014. Royal Dutch Shell, 2014, Annual Report 2013, Retrieved on 9th May 2017, from; reports.shell.com/annual-report/2013/servicepages/welcome.php shell annual report 2013. Royal Dutch Shell, 2013, Annual Report 2012, Retrieved on 9th May 2017, from; reports.shell.com/annual-report/2012/servicepages/about_disclaimer.php shell annual report 2012. Royal Dutch Shell (2012) Annual Report 2011, Retrieved on 9th May 2017, from; reports.shell.com/annual- report/2011/servicepages/downloads/files/entire_shell_20f_11.pdf shell annual report 2011. Watson, D&, Head, A2010, Corporate Finance Principles & Practice, 4th edition, Harlow: Pearson Chand, S2015, Theories of Capital Structure | Financial Management, Retrieved on 9th May 2017, from; http://www.yourarticlelibrary.com/financial-management/theories-of-capital-structure- explained-with-examples-financial-management/29398/ Accofina.com, 2013, Operating Cash Flow to Current Liabilities, Retrieved on 9th May 2017, from; http://accofina.com/calculators/liquidity-ratios/operating-cash-flow-to-current- liabilities.html Accounting-simplified.com, 2013, Dividend Coverage Ratio, Retrieved on 9th May 2017, from; http://accounting-simplified.com/financial/ratio-analysis/dividend-coverage.html Reed, S2016, Royal Dutch Shell’s profit down 56% on slumping oil prices, Retrieved on 9th May 2017, from; https://www.nytimes.com/2016/02/05/business/energy-environment/oil-prices-shell- company-earnings.html?_r=0 Mohr, A2017, How does Accounts receivable turnover ratio affect a company, Retrieved on 9th May 2017, from; http://smallbusiness.chron.com/accounts-receivable-turnover-ratio-affect-company- 61827.html Investopedia.com, 2017, Capital structure, Retrieved on 9th May 2017, from; http://www.investopedia.com/terms/c/capitalstructure.asp Accounting-simplified.com, 2013, Dividend Coverage Ratio, Retrieved on 9th May 2017, from; http://accounting-simplified.com/financial/ratio-analysis/dividend-coverage.html Appendix Calculations Profitability Ratios Net profit Margin (Operating Profit Margin) = Net Profit BIT (Operating profit)/Sales 2012 = $50,512/ 467,153× 100 = 10.81% 2013 = $33,592/451,235* 100 = 7.52% 2014 = $28,314/421,105 * 100 = 6.72% 2015 = $2,047/264,960 *100 = 0.77% 2016 = $5,606/233,591*100 = 2.40% Return on capital employed (ROCE) = Net profit BIT (Operating profit)/Shareholders funds + Non-Current Liabilities (Capital Employed)*100 = 2012 = $50,512/(176,182+ 77,133)*100 = 19.94% 2013 = $33,592/264,254 * 100 = 12.85% 2014 =$28,314/(172,786 + 94,118)*100 = 10.6% 2015 = $2,047/269,209* 100% = 0.76% 2016 = $5,606/ 337450 = 1.66% Efficiency Ratios Receivable Turnover = Account Receivables/ Sales *365 (Days) 2012 = $74,394/467,153*365 = 58.13 = 59 days 2013 = $72,829/451,235*365 = 58.91= 59days 2014 = $66774/ 421,105 * 365 = 57.87 = 58 days 2015 =$54,501/264960* 365 = 75 .08 = 76days 2016 = $55,217/233,591* 365 = 86. 28 = 87 days Payables turnover = Account payables/Cost of sales *365 days 2012 = 77,014/395,940 = 71 days 2013 = 74,177/ 381,585 = 70.95 = 71 days 2014 = 68,446/357,316 =69.92 = 70 days 2015 = 57,298/222739 =93.89 = 94 days 2016 = 60,342/191008 = 115.31= 116 days Gearing Ratios Gearing ratio = Total Debt/Total Equity 2012 = 174,112/176,182 = 98.83% 2013 = 176,364/181,148 =97.34% 2014 = 180,330/172,786 = 104.37% 2015 = 176,036/164,121= 107.26% 2016 = 222,764/ 188,511 = 118.17% Cash interest cover = (Cashflows generated from operations + Dividends received + Interest received)/ Interest 2012 = (46,140+193)/ 1,543 = 30.03 times 2013 = (40,440+ 175)/ 1,448 = 28.05 times 2014 = (45,044 +174)/1,598 = 28.29 times 2015 = (29,810 +288)/1,529 = 19.68 times 2016 = (20615+ 470)/2,752 = 7.66 times Liquidity Ratios Current Ratio = Current Assets/ Current Liabilities 2012 = 114,734/96,979 = 1.18 2013 = 103,343/ 93,258 = 1.11 2014 = 99,778/ 86,212 = 1.16 2015 = 93,358/70,948 = 1.32 2016 = 86,569/73,825 = 1.17 Operating cash flow to Current liabilities = Net cash flow from operating activities / Current liabilities 2012 = 46,140/96,979 = 0.48 2013 = 40,440/ 93,258 = 0.43 2014 =45,044/86,212 = 0.52 2015 = 29,810/70,948 = 0.42 2016 = 20,615/73,825 = 0.28 Investor Ratios: Dividend per share = Total dividends paid/ No. of ordinary shares 2012 =1.71 2013= 1.78 2014 =1.86 2015= 1.88 2016 = 1.88 Dividend cover = EPS/ Dividend per share 2012 = 4.27/1.71 = 2.5 2013 = 2.60/1.78 = 1.5 2014 = 2.36/ 1.86 = 1.3 2015= 0.31/1.88 = 0.16 2016 = 0.58/1.88 = 0.31 Competitors and Industry Performance Exxon Mobil B.P Chevron Total SA Royal Dutch Shell Industry Net profit Margin 2012 17.44 4.8 20.09 11.89 10.81 13.01 2013 13.71 7.8 16.31 10.43 7.52 11.15 2014 13.10 1.4 15.56 5.45 6.72 8.45 2015 8.47 -4.29 3.73 3.89 0.77 2.51 2016 3.64 -1.25 -1.96 4.79 2.40 1.52 Return on capital employed 2012 29.19 8.42 18.7 19.47 19.94 19.14 2013 20.98 12.98 16.27 15.36 12.85 15.69 2014 18.12 2.24 13.32 7.30 10.60 10.32 2015 7.76 2.39 2.03 3.72 0.76 3.33 2016 2.82 -4.67 -0.95 4.07 1.66 0.70 Gearing ratio 2012 94.45 150.96 0.69 136 98.83 96.19 2013 92.14 134.41 67 132 97.34 104.58 2014 93.02 152.40 70 146 104.37 113.16 2015 90.46 166.12 72 135 107.26 114.17 2016 90.02 171.90 77 127 118.17 116.82 Interest cover 2012 171.77 19.10 - 34.48 30.03 51.08 2013 4990.44 19.76 - 32.05 28.05 1014.06 2014 157.75 28.53 - 34.24 28.29 49.76 2015 97.57 14.20 - 20.63 19.68 30.42 2016 48.75 6.38 63.91 14.91 7.66 28.32 Current Ratio 2012 1.01 1.19 1.6 1.38 1.18 1.27 2013 0.83 1.33 1.5 1.37 1.11 1.23 2014 0.82 1.37 1.3 1.45 1.16 1.22 2015 0.79 1.28 1.35 1.38 1.32 1.22 2016 0.87 1.16 0.93 1.33 1.17 1.09 Operating cash flow to current liabilities 2012 0.87 0.26 1.13 0.46 0.48 0.64 2013 0.63 0.29 1.06 0.48 0.43 0.58 2014 0.70 0.51 0.99 0.48 0.52 0.64 2015 0.56 0.35 0.76 0.39 0.42 0.50 2016 0.46 0.18 0.40 0.30 0.28 0.32 Receivables turnover (days) 2012 33 34 38 35 59 39.8 2013 34 45 36 33 59 41.4 2014 31 32 31 25 58 33.8 2015 35 41 37 24 76 42.6 2016 44 45 47 30 87 50.6 Payables turnover (days) 2012 5 49 59 63 71 49.4 2013 21 53 62 43 71 50 2014 58 48 58 40 70 54.8 2015 72 63 71 63 94 72.6 2016 84 117 86 74 116 95.4 Dividend per share 2012 2.18 0.33 3.51 2.34 1.71 2.01 2013 2.46 0.365 3.9 2.38 1.78 2.18 2014 2.70 0.39 4.21 2.44 1.86 2.32 2015 2.88 0.40 4.28 2.44 1.88 2.38 2016 2.98 0.40 4.29 2.45 1.88 2.4 Dividend cover 2012 4.5 1.75 3.820. 2.01 2.5 2.92 2013 3.0 3.39 2.87 1.57 1.5 2.47 2014 2.8 3.15 2.43 0.77 1.3 2.09 2015 1.3 -5.3 -0.57 0.89 0.16 -.70 2016 0.6 0.1 0.06 1.03 0.31 0.42 Read More