Shell seals BG acquisition, but integration may prove tougher

Royal Dutch Shell (LON:RDSA) has sealed its $53 billion acquisition of BG Group, a deal that’s going to create the world’s biggest producer of liquefied natural gas, but it now has to prove to investors that it can drive big benefits from the integration of its British rival.

FTSE 100-listed Shell announced it had reached a recommended cash and shares deal for BG last April, when the oil price was at about $60 a barrel. It had to overcome plenty of hurdles to get a deal, including clearance from regulators in several jurisdictions and the approval of its own shareholders, but eventually overcame all these.

That was despite growing scepticism among several analysts about the merits of a deal as the oil price continued to tumble to just above $30 a barrel currently. The fear was that the BG deal would put a further strain on Shell’s balance sheet and hamper its ability to get things done through period of protracted low oil prices.

Analysts are now largely positive about Shell’s prospects, even though the drop in the oil price is going to make the integration of BG and the benefits it will bring to the enlarged company a more drawn out process.

Four analysts currently have Shell at Strong Buy, six at Buy, five at Hold and just one at Sell, according to data compiled by Thomson Reuters. Two of the last three broker ratings changes have been upgrades.

Shell’s share price has fallen over the past two years, but has outperformed the oil price

Source: Thomson Reuters

Shell recently reported that its key profit measure – calculated on a current cost of supply basis – dropped to $1.8 billion in the fourth quarter of 2015, from $4.2 billion a year earlier. For the whole of 2015, its profit fell to $3.8 billion, from $19.0 billion in 2014.

It wasn’t much better at BG Group. Its adjusted earnings before interest and tax fell to $2.43 billion in 2015, from $6.38 billion in 2014.

Still, Shell joined BP and other global oil majors in protecting dividend payouts despite the deterioration in its earnings. That’s in contrast to the mining sector, where most of the major producers have suspended payouts or altered dividend strategies as they attempt to restructure, cut costs and preserve cash.

Shell’s deal to buy BG means it will now be focused on two key areas: deep-sea oil and gas exploration and production and LNG.

“It significantly boosts our reserves and production and will bring a large injection to our cash flow. We have acquired productive oil and gas projects in Brazil and Australia and other key countries. We will now be able to shape a simpler, leaner, more competitive company, focusing on our core expertise in deep water and LNG,” says Shell Chief Executive Ben van Beurden.

The Shell CEO was on a trip to Brazil, where the BG deal has significantly increased the company’s presence. Shell’s output in Brazil had been in decline, but it will now be junior partner to state-owned Petrobras in several of the country’s biggest discoveries. However, it’s a tricky time to be doing business in recession-hit Brazil, particularly in the oil sector where Petrobras is embroiled in scandal where it’s being accused of bribery and political kick-backs.

Still, Shell expects to invest in Brazil and quadruple oil and gas output from the country by 2020, according to the CEO. The company’s gearing will rise to about 20%, from 14%, now the BG deal is completed, but Shell still has room to borrow to make investments, he says.

Van Beurden also reiterated that he believes the oil price will stabilise in the second half of 2016 and then start recovering. This prediction would be very helpful to Shell as it moves forward with the integration of the BG assets. At the end of the day, the oil price is crucial to the enlarged oil major, and a rising oil price will help it generate the returns it has promised to get out of the BG acquisition without putting further strain on its balance sheet.