Executive summary
Royal Dutch Shell PLC commonly known as the shell is second largest energy company in the world whose registered office is in London. It is oil and Gas Company operating in various parts of the world; to stay relevant to climatic and environmental changes it engages in both renewable and non renewable energy. In addition, it is a vertically integrated oil company which engages in all oil activities from exploration to refining and marketing. Apart from its core activities, it has entered into partnership with various international organizations to preserve the environment. The company shares are listed in London stock exchange, and its financial statement are presented in accordance to IFRS. The company main competitor is BP Petroleum Company which is also a multinational company (Investors hand book 2011).
Accounting policies used by Shell
The company uses GAAP in its accounting activities. Precisely, current assets e.g. Inventories are accounted at lower of cost or net realizable value. On the other hand, the company property plant and equipments are depreciated on the basis of units of production. However, straight line method is used when the useful life of the asset is considerably shorter than life of the field concerned. Property, plant, and equipment are usually reviewed for possible impairment annually. Assets held for sale are reported at lower of either the carrying amounts or fair value less cost of disposing them. While inventories are accounted at lower of cost or net realizable value. BP recognizes assets held for sale in the same way (Investors hand book 2011).
Exploration costs are termed as expenses and treated just like other expenses however, expense pertaining drilling which are included as part of property plant and equipment utilized in the drilling. Associated companies, which are not under control of the shell, is accounted using the equity method while, jointly controlled entities are accounted using the equity method. Its main competitor BP uses the equity method when accounting for joint ventures. The policies adopted by Shell seem to fit very well petroleum company. The auditors have given their opinion that the financial statements represent true and fair view of the business conditions in accordance to IFRS. This means that the company has adhered to the international accounting standards.
Financial analysis
ROCE
ROCE sets a limit of the cost of capital above which a company must not obtain external financing. In 2008 Shell could borrow capital at a maximum cost of 18% but this limit fell to 8% in 2009 but it rose to 11.5% in 2010. This gives the limit for cost of borrowing. On the other hand, BP has its ROCE dropping over years meaning that the company’s limit or cost of capital has been dropping over years. This means that Shell can acquire capital at a higher cost in 2010 than its main competitor BP.
Gross profit margin
Shell gross profit margin did not decrease in 2009 irrespective of financial crisis of the year this is attributable to increase in energy demand in ASIA which was enough to cushion the company against the global financial crisis. Comparing the two margins it is clear that BP had a higher GP margin in 2008 and 2009 meaning that it sold its stock at a higher price in those two years. However, in 2011 the two companies GP ratio was almost the same indicating that the price competition was intense.
Current ratio
This ratio aims at scrutinizing whether a company can pay its current liabilities as they fall due. This safeguards the company’s image among suppliers and financial institutions which may offer the company short term financing.
The following table represents current ratio for Shell and BP Company since 2006
The shell’s current ratio has remained above one meaning that the company cannot have any problem meeting its current liabilities as they fall due. Comparing with BP’s current ratios, Shell current ratio has remained considerably above meaning that its current ratio is appropriate. This ratio is sufficiently high given that the company’s stock is readily disposable.
Quick ratio
It is also known as acid test ratio, it is a measure of liquidity that estimates the company’s position to pay off its current liabilities by disposing off its current assets except stock; since, stock is not easily sold. This ratio does not apply where stock is easily converted into cash.
Source (BP, 2011)
Shells quick ratio has remained below one meaning that it may need to sell its inventory so as to meet its current liabilities. However, this is not a major problem to the company because its stock is easily disposable. The graph clearly shows that Shell’s quick ratio dropped below BP’s since 2008. Taking into consideration that the BP quick ratio is below one it means that the management of shell has not faced liquidity problems in all the previous years.
Gearing ratio
This is a leverage ratio which attempts to compare company’s liabilities to the entire company’s equity. It therefore gives the composition of company’s capital. If the ratio is high then it means that the company has relied extensively on external financing as compared to internal financing.
Shell Company has maintained its debt to equity ratio below 0.5 this clearly shows that it is relying more on internal financing than external financing. This shows that it is less likely for the company to be forced to wind up by creditors. BP’s debt equity ratio is consistently below that of Shell Company implying that it has lower debt (shell,2012)Stability ratios
It tells how easily the company can pay its interest expense. The lower the ratio the higher the burden of interest expense for the company. It is a very useful ratio to financial institutions which are willing to advance loan to a company because they easily determine whether they will be paid back.
Shell interest cover has been increasing since 2006 but it decreased in 2009 due to low profit caused by global financial crisis. However, its interest cover trend shows clearly that the company can pay its interest expense comfortably. Comparing with BP, Shell has got more comfortable interest cover.
Working capital cycle
It is the time period between acquisition of stock and the time when the stock is disposed and cash received. Therefore it is got by the following formulae; Accounts Receivable Turnover in Days+ Inventory Turnover in Day.
Shell’s working capital has been above 50days since 2006 except when it fell in 2008 to 40 days. This shows that it takes the company more than 50 days to sell and receive payment against its stock. The working capital cycle of BP has fluctuated just like that of shell. This means that those days are adequate in petroleum industry. The fall of the graph in 2008 was attributable to fall in debtor days.
Efficiency ratios
It is a ratio which tries to scrutinize how effective is the company utilizing its assets to generate sales revenue. High asset turnover is an indication of better asset utilization.
Shell and BP have their ratio so close to each other, therefore it can be concluded that, shell has maintained efficiency utilization of company assets within industry’s requirements.
Average payable payment period
This is the number of days a company takes to pay for its credit purchases. Few days indicates that the company’s credit suppliers are having an easy time while collecting their money from the company.
Average payable payment period= (average debtors/credit sales)*365
The creditor’s days for Shell Petroleum Company have been above 30 except that they fell to 20 in 2008. It is clear that the trend followed by debtor days is the one followed by creditors’ days. This means that Shell can partly collect cash from credit customers and use it to clear its invoices. It can also be clearly seen that the average payable period for BP and shell are fluctuating in the same way meaning that shell company payable period within industries requirement.
Receivable collection period
This is average days the debtors will take to pay the credit sale extended to them. The lower the debtor collection period the higher the efficiency of the company in collecting debts
Receivable collection period= (average debtors/credit sales)*365
Inventory processing period
This is number of days a company takes to convert its stock into sales. Increasing inventory period depicts that a company is taking more days to sale its stock. This may means that its profit may fall due to decreased demand for its products.
The graph shows that it takes Shell considerably almost the same days it takes BP to dispose its stock. In 2008 the days fell drastically however they increased again in 2009 (Shell Dutch company, 2011).
Profitability ratios
Return on sales; it is used to show the fraction of sales on net income. High profit margin means that the operating expense is low, but when the margin starts to fall due to decrease in net income without considerable fall in sales then operating expense must be increasing.
The ratio has considerably fallen since 2006, it reached its lowest in 2009. However it seems that shell was able to recover in 2010 from the world financial crisis. This is attributable to the increased demand of energy in ASIA countries. BP had a favorable return on sales ratio in 2009 meaning that it was less affected by the global financial crisis than Shell.
Return on equity
Return on equity ratio estimates the profitability of the company in relation to share holders’ equity. High return on equity reveals that the business is able to generate cash internally. Return on equity ratio accounts for how much the company effectively reinvests retained earnings. It is calculated from the formula shown below.
Return on Equity = Net IncomeEquity*100%
Source ( London stock exchange 2012)
P/E= Market Value per Share Earnings per Share (EPS)
Investors prefer companies with high P/E. therefore this ratio makes sense when compared to companies in the same industry.
Source (London stock exchange, 2011)
Comparing the P/E of the two companies it seems that one cannot make definite decision on which company to invest in. However, it is clear that before 2009 it could be better to invest in BP while after 2009 it seems better for an investor to prefer Shell. Shell‘s PE in 2009 rose above that of BP because it took advantage of increase in fuel demand in ASIA in addition the company reacted swiftly to the 2009 economic down turn reconstructing the company.
Dividend yield
It is calculated using the formulae (Annual dividends per share/price per share)*100%.
It gives return on investment of each dollar in absence of capital gains.
The trend shows that an investor expects 4% to 6% for every dollar invested in Shell shares. In 2006 to 2009 BP had a higher dividend yield than shell but its yield fell drastically to 1% in 2010. In 2010 BP‘s ratio fell to zero because the company was experiencing a lot of problems.
Earnings per share
Earnings per share of Shell are considerably higher than that of BP. Earnings per share in 2006 were 3.89 the amount grew to 4.03 in 2007 and analysts expected this growth trend to continue (digital The mathematic maps, 2008). However, from the above trend it can be seen that the earnings increased in 2008 but they fall in 2009 due to international financial crisis. According to industry weekly report 2010 the earnings per share was expected to increase in several years after 2010 because the company was not only investing heavily in ASIA but was also cutting down on costs. This happen because if you consider share price movement for shell in 2011(refer the graph below) it shows a upwards trend.
Conclusion
Most of shell financial ratios have been stable overtime. In addition, the company ratios are generally better than that of its main competitor BP. The company uses GAAP in accounting for assets and liabilities, and IFRS in presentation of information in financial statements. The stock price performances of the company have also been responding positively to the predictions and expectations of analysts. This is stressed by the prediction made in 2010 that the share prices in 2011 were to increase despite increased industrial competition and previous global financial crisis.
References
BP ,2011. An archive of BP annual reporting publications and presentations, available for you to download. (accessed on 8th dec, 2012)
Digital thematic maps, 2008. Earnings per share of royal Dutch shell PLC. Available at (accessed on 8th dec, 2012)
shell, 2011. Financial Report. Available at: (accessed on 8th dec, 2012)
Investors hand book ,2012. Shells PLC performance since 2006. Available at .(accessed on 8th Dec, 2012)
Idustry weekly, 2010. Connecting manufacturing leaders available at.(accessed on 2rd Dec, 2012)
Shell Dutch company (2012). Royal Dutch shell annual report and form 20-f for the year ended December 31 2011. (Accessed on 8th Dec, 2012)
