On Aug 21, 2013, we retained our Neutral recommendation on
Europe's largest oil company
Royal Dutch Shell plc
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Why the Reiteration?
Royal Dutch Shell is one of the largest integrated energy firms
in the world with a strong and diversified portfolio of
development projects that offer attractive long-term
opportunities. The group - renowned for its success in
bringing some of the largest and most technically challenging
capital-intensive projects to fruition - is expected to continue
accelerating revenue and earnings growth over the next few
quarters. A healthy dividend yield and reasonably cheap valuation
are other positives in the Shell story.
However, the company is particularly susceptible to its high
exposure to the downstream business, as well as its major natural
gas focus and lofty capital spending.
Royal Dutch Shell has outlined plans to boost its focus on the
more lucrative and well performing 'upstream' exploration and
production end of the business. The group expects annual
worldwide production to increase some 20% by 2017-2018 (from 2012
levels), driven by a new wave of project startups. Shell's
targeted output advance represents one of the most ambitious
growth programs in the sector, which will be achieved primarily
by new projects coming onstream in Qatar, Australia and North
America. The company currently has approximately 30 projects
under construction that should guarantee upstream growth for
years to come.
Of particular significance is the group's leading position in
natural gas. Royal Dutch Shell is the second largest natural gas
producer in the world. It has led its super major peers in
monetizing its substantial worldwide equity natural gas resource
base by investing in liquefied natural gas (LNG) and
Gas-to-Liquids (GtL) technologies. Shell has been a frontrunner
in the LNG and GtL spaces, backed by years of research and
development, extensive expertise, multi-billion dollar
investments and cordial relationships with partners/governments
Royal Dutch Shell's current dividend, while providing a healthy
yield of some 6%, caps the payout ratio around a very manageable
45%. Importantly, the cash-rich company - which last year raised
its payout for the first time since 2009 - has done the same for
2013 as well.
However, as is the case with other companies engaged in the
business of exploration and production, Shell's results are
directly exposed to oil and gas prices, which are inherently
volatile and subject to complex market forces. Realized prices
could differ significantly from our estimates, thereby affecting
the company's revenues, earnings and cash flows.
Additionally, Royal Dutch Shell is the most gas-focused among the
major companies in the sector, with more than half of its current
production from the commodity. Given natural gas' volatile
fundamentals, this remains a key area of concern, in our view.
Finally, Royal Dutch Shell projects investment of some $34
billion in 2013, quite high by industry standards. This is
expected to substantially increase the group's leverage and
deteriorate its credit metrics during the current downturn.
Additionally, the increasing capital intensity of its operations
may result in reduced returns going forward.
Stocks That Warrant a Look
While we expect Shell to perform in line with its peers and
industry levels in the coming months and advice investors to wait
for a better entry point before accumulating shares, one can look
Range Resources Corp.
Clayton Williams Energy Inc.
Matador Resources Co.
) as good buying opportunities. These domestic upstream energy
operators - sporting a Zacks Rank #1 (Strong Buy) - have solid
secular growth stories with potential to rise significantly from