Morning Note: Market news and updates from Shell and Constellation.

Market News

The yield on the US 10-year Treasury is currently 4.05% on Friday, back to the mid-December level, after the latest jobs report showed the labour market remains strong reinforcing the view that the Fed would need to wait longer with the rate cuts. The US economy added 216K jobs in December, compared to 173K in November and much above market expectations of 170K. Equity markets ended a weak week on a flat note.

The focus this week will be on US inflation (and its impact on the direction of interest rates) and the start of the Q4 earnings season. Goldman expects US corporate earnings to rise even further, with S&P 500 companies’ EPS climbing 5% to $237 in 2024. Even that may still be too low, the bank’s strategists said. Separately, a majority of respondents in a MLIV Pulse survey said the biggest risk to earnings this year is a recession.

This morning in Asia, markets were lower on concern over tighter regulation on the gaming industry and fears the Chinese government’s efforts to bolster the economy are insufficient: Hang Seng (-2.0%); Shanghai Composite (-1.4%); Nikkei 225 (flat). The S&P Futures currently predict a 0.1% drop at the open this afternoon. The FTSE 100 is currently trading 0.2% lower at 7,675, while Sterling is $1.2682 and €1.1603. Gold slipped to $2,028 an ounce. Crude oil is trading down more than 1% at $78 a barrel as Saudi Arabia price cuts offset Middle East supply worries.

US congressional leaders announced a bipartisan deal on top-line spending levels for the current fiscal year, lessening the chances of a partial government shutdown on 20 January. Chuck Schumer and Mike Johnson negotiated the framework, clearing the way for the Senate and House to work out detailed spending bills. Joe Biden welcomed the agreement.

Biotech investors are heading into this week’s JPMorgan health-care conference with renewed optimism for dealmaking. Drugmakers desperate to fill pipelines announced more than $50bn in biotech deals last quarter — including $27bn in December alone.

Source: Bloomberg

Company News

Shell has today released its fourth quarter update note which provides an overview of its current expectations for the three months to 30 June. The release coincides with overnight weakness in the oil price, pushing the shares down 2% in early trading.

Shell is an international energy company with expertise in the exploration, production, refining, and marketing of oil and natural gas, and the manufacturing and marketing of chemicals. In the ‘upstream’ business (i.e., exploration & production), four fifths of the profit come from eight core regions: Gulf of Mexico, Brazil, Nigeria, UK, Kazakhstan, Oman, Malaysia, and Brazil. The company is a key player in the LNG market, which is expected to remain tight over the medium term. As part of an integrated energy strategy, Shell is allocating capital to low and zero carbon products and services including wind, solar, advanced biofuels, and hydrogen.

The group’s strategy is to invest in providing secure supplies of energy, while actively working to reduce carbon emissions.  Capital spending will fall from $23bn-$27bn in 2023 to $22bn-$25bn in 2024 and 2025, with the aim to invest $10bn-$15bn across 2023 to 2025 to support the development of low-carbon energy solutions. The group is also aiming to increase efficiency, with annual operating costs reducing by $2bn-3bn by the end 2025.

In the final quarter of 2023, production in the Integrated Gas business is expected to be between 880kboe/d and 920kboe/d, in line with last quarter. Trading & Optimisation in the unit is expected to be significantly higher than the previous quarter due to seasonality and increased optimisation opportunities. In the Upstream division, production is expected to be between 1,830kboe/d and 1,930kboe/d, and increase on Q3. Marketing results are expected to be in line with the previous quarter. In the Chemicals & Products division, trading & optimisation is expected to be significantly lower than the previous quarter. Overall, the segment is expected to make an adjusted earnings loss in the quarter as refining margins fell.

Post tax impairments of $2.5bn-$4.5bn are expected for the quarter, primarily driven by macro & external developments as well as ‘portfolio choices’ including the Singapore Chemicals & Products assets.

As expected, there is no comment in today’s statement on the group’s financial position or shareholder returns. Further disclosure will come with the full-year results on 1 February. As a reminder, at the end of the Q3, net debt was $40.5bn, with gearing a comfortable 17.3%. Shell’s current policy is to return 30%-40% of cash flow from operations (CFFO) to shareholders through the cycle through a combination of dividends and share buybacks.

We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, is increasingly leading to constrained supply.

In common with all the oil majors, Shell is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic uncertainty. Despite strong performance over the last three years, the shares remain on an undemanding valuation, both in absolute terms and relative to the US majors, which fails to consider the potential for free cash flow generation and shareholder returns. We believe they also provide something of a hedge against inflation.

Source: Bloomberg

On Friday lunchtime, Constellation Brands released results for the third quarter of its financial year ending 28 February 2024 (FY24). Performance was robust and the group raised its guidance for the full year. The US-listed shares were marked up 2% following the update.

Constellation Brands is a leading international producer and marketer of beer, wine, and spirits, with a portfolio of higher-end brands including Corona, Modelo, and Robert Mondavi. Part of the group’s strategy is to supplement organic growth with bolt-on acquisitions, and to focus on premium, margin accretive, growth opportunities. The group also owns a stake in Canopy Growth Corporation, a listed Canadian medical marijuana company.

In the three months to 30 November 2023, net sales grew by 1% to $2.47bn, a touch below the market expectation of $2.54bn. Comparable EPS (excluding the loss from the Canopy investment) rose by 8% to $3.24, well above the market expectation of $3.00.

By division, the beer business delivered good growth, primarily driven by continued momentum of the Modelo brand family. Net sales were up 4% to $2.0bn, while depletion growth was 8.2%, reflecting continued strong demand across the high-end portfolio. The business continued to outperform the market with five of the top 15 share gaining brands. The operating margin fell by 100bps to 38.5%, as benefits of net sales growth, pricing, and marketing spend, and cost efficiencies offset higher raw materials costs due to ongoing inflationary pressures.

In Wine & Spirits, sales fell 7% in organic terms to $502m, although strong performance was achieved across premium wine brands. The operating margin grew 60bps to 25.4%, as benefits from lower freight, warehousing, material costs, and planned efficiencies in marketing expense were partially offset by shipment volume declines.

The business is cash generative, although free cash flow year to date was down 10% to $1.4bn, driven by brewery capacity investments. Net debt ended the quarter at $11.6bn. The group’s share of Canopy losses fell from $37m to $7m during the quarter. The group returned $215m to shareholders in share repurchases and declared a dividend of 89c in the latest quarter, up 11%.

The company is expanding its beer business in Mexico and expects to spend $4.0bn-$4.5bn between FY24 and FY26 to support the future growth of the core, high-end Mexican beer portfolio and up to 30m hectolitres of additional total capacity. This year, the group will spend $1.0bn on the project out of a total capital expenditure of $1.2bn-$1.3bn.

The group reiterated its guidance for FY24 for comparable basis EPS at $12.00-$12.20 but raised its target for free cash flow from $1.2bn-$1.3bn to $1.4bn-$1.5bn. The group continues to expect Beer net sales growth of 8%-9%, while Wine net sales is now expected to decline by 7%-9%, a slight upgrade.

Source: Bloomberg