Shell’s profit gusher not as productive as it looks

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Profits are like oil: great resources to have, but greater still when converted into hard cash. Royal Dutch Shell pumped out more oil and gas and made a decent fist of improving profits in the first quarter. Its cash conversion rate, however, was horrid. The Anglo-Dutch oil major burnt through $1.3bn (£847m); that followed a $4.5bn cash burn the previous quarter.

Drilling for oil is clearly a licence to sink money. Shell’s annual capital expenditure bill should be about $25bn-$30bn over the next five years. Worse, European investors now expect it to provide a steady gusher of dividends. Shell needs to generate $40bn of cash simply to pay these bills; last year, it managed just half that. As last quarter showed, cash leakages occur elsewhere too. Shell’s working capital increased by $5.6bn last quarter. Some of this was bound up in inventory: crude oil caught in the supply chain at end-2009 and that has subsequently increased in value. More still, perhaps $3.5bn, relates to trading positions. (Before fund managers panic that their company has morphed into a Master of the Universe, there are strict limits on value at risk and Shell inevitably has a better inside track on oil flows than even Wall Street’s finest).

Keeping cash churning is vital for an industry obliged to write big cheques and at the mercy of fluctuating market prices. Shell has done no worse than its immediate peer – indeed, it consumed a bit less cash than BP. But it need not be this way. PetroChina, the Chinese giant, not only reported bumper first-quarter profits but also generated $7.4bn of cash. Alas for the latter’s investors (mainly Beijing), aggressive expansion plans suggest that even in China, cash conversion rates may become less robust.

Retail twins stick together

Keep one statistic in mind when considering whether Home Retail Group should be broken up into its Homebase and Argos units: two-thirds of product categories available from the DIY superstore are also available from the bricks, clicks and catalogue retailer.

When Great Universal Stores acquired Homebase in 2002, the savings achievable were put at £20m a year, later increased to £40m. The benefits of joint buying are probably even more significant now. GUS successfully split itself into the sum of its parts later. Now some analysts think the same could be done to cash-rich Home Retail. It obviously could – at a price – but Terry Duddy, chief executive, makes a forceful case for continued unity.

The blemish in his vision is the underperformance of Home Retail against peers and the wider market. Even after Wednesday’s allegedly unrelated promise of a £150m share buy-back, the stock slipped to 277p, a 25 per cent discount to racier break-up valuations circulating in the City. That makes the shares, on a 5 per cent prospective yield and a multiple of 12 times forward earnings, worth hanging on to, just in case.

But Home Retail needs something more. The downturn allowed Argos to scavenge for retail brands – Chad Valley (from Woolworths), Hygena and Schreiber (from MFI) – but it also drove down like-for-like sales. Worse, it hit sterling, nullifying some of the impact of Home Retail’s fabled joint purchasing power by pushing Asian-built product costs up and gross margin rates down at both Argos and Homebase.

That makes the other new use for Home Retail’s cash pile – to increase capital spending and refresh the Argos brand and stores for the first time in a decade – potentially more significant than the promised buy-back. With Home Retail’s dependence on the UK about to be tested by draconian spending cuts and tax rises, some new magic is needed to attract customers. Otherwise, it will only be a matter of time before someone else concludes it really is worth trying to separate Mr Duddy’s retail twins.

BP’s pay safety catch

BP executive directors are rightly focusing on the immediate human and environmental aftermath of the explosion on the Deepwater Horizon drilling rig in the Gulf of Mexico. But they have an added spur to deal with the incident as efficiently, cleanly and safely as possible. Two weeks ago, BP shareholders voted to tighten the conditions on executive directors’ annual bonuses. From this year, one-third will be paid in deferred shares, which could be clawed back if there has been “a material deterioration” in safety and environmental measures, or “major incidents [reveal] underlying weaknesses in safety and environmental management” in the following three years. How much BP’s top team expect to be paid will not affect how they handle the tragedy of Deepwater Horizon. But how they handle it may yet affect how much they are paid.

andrew.hill@ft.com

Shell: louise.lucas@ft.com

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