Reaction to Shell and Imperial Brands updates

Shell Q3

The Q3 numbers from Shell (LSE:SHEL) will be finally confirmed at the end of this month, but this production update provides some particular areas of growth which should please investors.

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Refining margin increased from $8.9 to $11.6 per barrel, while upstream production was also increased to a range between 1,790 and 1,890 (thousands of barrels of oil equivalent per day) from a previous 1,732, with an additional boost coming from gas trading where earnings are expected to be significantly higher than the last quarter. Impairments and ongoing losses in the Renewables business may take off some of the shine, but for the most part the numbers are robust against a difficult backdrop.

Indeed, the share price has risen by 10.5% so far this year in an ongoing display of financial resilience, despite a decline of 12% in the oil price. The confirmed results will likely contain details of a new buyback, while the previously announced dividend increase leads to a yield of 3.9% as part of Shell’s progressive policy and to a level which is sufficient to tempt income-seekers.

Despite heightened geopolitical tensions and a current glut of supply overhanging the sector, Shell is now undergoing more conservative capital expenditure, thus underpinning shareholder returns. In addition, its diversity of operations across oil, gas, chemicals, and retailing regularly allows one area of strength to counter another of weakness. Management’s previous estimate that the dividend could be sustained even with the oil price as low as $40 per barrel - currently $65.70 – is noteworthy, while a focus on reducing costs continues.

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Over the last year, the shares have added 6%, as compared with a gain of 14% for the wider FTSE100, but investing in Shell has always represented a marathon rather than a sprint, with incremental progress expected. As a stock, Shell faces the additional challenge of being in a sector which is the focus of some debate from an environmental perspective, with the ever-increasing possibility that some investors will be unwilling or unable to invest in the sector on ethical grounds.

Even so, this update means that two core considerations are unlikely to change. Firstly, that the company remains a core constituent of many traditional portfolios alongside the old adage of “never sell Shell” and, secondly, that the market consensus of the shares as a buy and the preferred play in the sector over BP will stay in place.

Imperial Brands trading statement

Changing lifestyle habits and tougher regulation perennially overhang the tobacco sector, but in the meantime Imperial Brands (LSE:IMB) continues to play the cards it has been dealt with aplomb.

Quite apart from the changing landscape and the burden of regulatory censure which has plagued the sector over recent years, there is also a reluctance among some investors to invest in tobacco companies at all on ethical grounds. As such, the tobacco companies are racing towards Next Generation Products (NGP) as an alternative, and are doing so from a relatively recent standing start. Even after some years of investment, the NGP unit is still loss-making for Imperial, although there are clear signs of progress. Net revenue growth for the year is likely to be somewhere between 12% and 14%, with losses broadly flat year on year.

In terms of outlook, the group is focused on completing its current five-year strategic focus, with details of the next leg of the strategy to be announced in the near future. In the meantime, the group has confirmed previous guidance of low single-digit tobacco growth and adjusted operating profit to mirror that of last year.

Elsewhere, the tobacco majors continue to benefit from the extraordinary cash generation which their sector enables. Tobacco remains a product which has inelastic demand, providing the ability to raise prices without unduly dampening demand, and this pricing mix has seen the benefit as a result, with falling volumes more than offset by higher prices.

As such, the group retains its ability to choose between shareholder returns, investment in the business, paying down debt or indeed all of these.

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At the present time, shareholder returns are in sharp focus, with the announcement of a further share buyback of £1.45 billion, as part of a multi-year programme. At the same time, a dividend yield of 5.3% adds to what has been a significant total return for shareholders. The aggressive shareholder return programme should, all things being equal, continue to underpin the share price.

Apart from the additional dividend bonus, the share price has risen by 40% over the last year, as compared to a gain of 14% for the wider FTSE100, and the shares have now added 80% over the last two years while the transformation programme has been in full swing. Even after such a climb, the shares are not obviously expensive in terms of historic valuation. Despite the obvious concerns of changing habits and a more immediate drag from some large investors either unwilling or unable to buy tobacco shares, Imperial is maximising its current power, and the market consensus of the shares as a buy continues to reflect this bounty.