Royal Dutch Shell p.l.c. (Class A) - ADR
/ (RDS.A-NYSE)/ Equity Research / RDS.A | Page 7
Current Recommendation / UNDERPERFORM
Prior Recommendation / Neutral
Date of Last Change / 11/23/2014
Current Price (01/30/15) / $61.45
Target Price / $56.00
SUMMARY
Following Royal Dutch Shell’s fourth quarter profit miss, we are maintaining our recommendation on the integrated energy giant at Underperform. Predictably, the oil price slump has adversely affected the group’s earnings and cash flows, particularly at its upstream unit. Furthermore, lost reserves/production from Shell’s asset sales in Nigeria and heightened risk related to the company’s remaining operations in the country cannot be ignored either. We also expect Shell ADRs to remain soft due to its major natural gas focus and lofty capital spending. Considering these headwinds, we expect Shell to perform below the industry, which gives investors little reason to hold the stock./ Equity Research / RDS.A | Page 7
SUMMARY DATA
52-Week High / $83.1252-Week Low / $60.93
One-Year Return (%) / -5.87
Beta / 1.24
Average Daily Volume (sh) / 4,826,245
Shares Outstanding (mil) / 3,160
Market Capitalization ($mil) / $194,191
Short Interest Ratio (days) / 0.92
Institutional Ownership (%) / 8
Insider Ownership (%) / 1
Annual Cash Dividend / $3.76
Dividend Yield (%) / 6.12
5-Yr. Historical Growth Rates
Sales (%) / 5.9
Earnings Per Share (%) / 5.5
Dividend (%) / 2.6
P/E using TTM EPADR / 8.6
P/E using 2015 Estimate / 12.3
P/E using 2016 Estimate / 9.8
Zacks Rank *: Short Term
1 – 3 months outlook / 5 – Strong Sell
* Definition / Disclosure on last page
Risk Level * / Average,
Type of Stock / Large-Value
Industry / Oil-Intl Intgd
Zacks Industry Rank * / 258 out of 267
OVERVIEW
The original Royal Dutch/Shell Group had resulted from the 1907 alliance between U.K.-based Shell Transport and Trading Company and the Netherlands-based Royal Dutch Petroleum Company, with 40% and 60% stake in the group, respectively. However, both companies maintained their separate and distinct identities. The unification plan proposed in 2005 by the boards of both the companies was completed in 2006, resulting in one parent company, Royal Dutch Shell plc. Reflecting the 60:40 ownership structure of the group before the unification, Royal Dutch Petroleum Company’s shareholders were given a 60% stake in the new parent company through class A shares (RDS.A), while the old Shell shareholders were given a 40% stake through class B shares (RDS.B). The new company has a single board of directors, headed by a non-executive chairperson. Moreover, the group’s previously split central offices have been consolidated into a single headquarters in the Netherlands, where the board and the senior management team are based. Both classes of shares have been listed on the London, Amsterdam, and (in the form of ADRs) on the New York stock exchanges. Dividends are paid quarterly (as opposed to the previous practice of semi-annual payouts). Also, the group has started declaring dividend in U.S. dollars instead of euros.
The Royal Dutch Shell plc owns one of the largest integrated oil and gas businesses in the world. The group has operations all over the world and is involved in various activities related to oil and natural gas, chemicals, power generation, renewable energy resources, and other energy related businesses. Royal Dutch Shell divides its operations into three major segments: Upstream, Downstream, and Corporate.
Ø The group’s ‘Upstream’ business finds and extracts crude oil and natural gas, often in joint ventures with international and national oil companies. This segment accounted for major portion (approximately 72%) of Royal Dutch Shell’s 2014 earnings.
Ø The ‘Downstream’ unit processes crude oil into a slew of refined products, which are moved and marketed worldwide for domestic, industrial and transport use.
Ø The Corporate segment covers the key support functions, comprising holdings and treasury, headquarters, central functions, and Shell insurance companies.
In 2014, Royal Dutch Shell’s oil and gas production (including oil sands) averaged 3.080 million oil-equivalent barrels per day (MMBOE/d), of which 48% was liquid. As of year-end 2014, the group had approximately 13.1 billion oil-equivalent barrels (BBOE/d) per day in proved reserves and a combined refining capacity of approximately 3.3 million barrels per day (MMBbls/d), of which roughly 40% is located in Europe and Africa, 35% in the Americas, and 25% in Asia and Oceania.
REASONS TO SELL
Ø With crude prices tumbling 60% since June, Royal Dutch Shell’s upstream division has been able to extract less value for their products. This has pressured the group’s profit margins.
Ø Since the last few years, Shell’s energy establishments in Nigeria has come under a string of attacks from the country’s main militant group, thereby forcing the company to scale down local operations by selling assets regularly. Operating in Nigeria since 1937, Shell will have to substitute the lost reserves and production with new ones.
Ø 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.
Ø Despite announcing spending cuts of $15 billion over next 3 years, Royal Dutch Shell’s annual capital expenditure remains 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.
Ø Royal Dutch Shell conducts operations in many countries. As such, the group is exposed to risks associated with doing business abroad. Such risks include embargoes and/or expropriation of assets, exchange rate risks, terrorism and political/civil sentiment, etc.
RISKS
Ø Royal Dutch Shell’s results are heavily levered to changes in the overall energy price environment, 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. This may present a potential risk to our recommendation.
Ø The overall picture for natural gas remains gloomy, with production setting monthly records on a regular basis, while the commodity’s demand has failed to keep pace with this rapid supply surge. This growing demand supply imbalance pressurizes price. However, a quicker-than-expected rebound in gas prices will adversely affect our recommendation.
Ø Royal Dutch Shell’s current strategy to undertake major investments in unconventional and deepwater integrated projects and divest non-core assets may lead to a positive impact on the company’s financial condition and results of operations. This may hamper our recommendation.
RECENT NEWS
Fourth Quarter 2014 Results
On Jan 29, 2015, Royal Dutch Shell plc reported weaker-than-expected fourth-quarter 2014 earnings due to low crude price realization. Earnings per ADR (on a current cost of supplies basis), excluding one-time items and gains or losses from inventories, came in at $1.04, widely missing the Zacks Consensus Estimate of $1.34.
However, comparing year over year, Shell’s adjusted earnings per ADR improved almost 12% (from $0.93), owing to substantially higher refining profits across most of its operating regions.
Revenues of $92.4 billion saw a 15% deterioration from the year-ago figure of $109.2 billion.
Segmental Performance
Upstream: Earnings during the quarter (excluding one-time items) were $1.7 billion, down 30% from $2.5 billion (adjusted) earned in the year-ago period.
Significant lower oil price realization during the quarter primarily hurt the upstream business. This was however partially offset by an improved high-margin liquids output along with higher performance from operations.
Upstream volumes averaged 3.2 million oil-equivalent barrels per day (MMBOE/d), down 1% from the year-ago quarter. Natural gas volumes fell more than 1%, while crude oil output also decreased 1% from the corresponding quarter last year. Crude oil contributed approximately 48% to total volume, while natural gas accounted for the rest. Oil and gas field decline was mainly responsible for lower production.
Shell’s worldwide realized liquids prices were 25% below the year-earlier level, while natural gas realizations decreased by 12%. Natural gas prices in America fell 3% from the last year’s level.
LNG equity sales volumes of 6.20 million tons were 26% higher than the year-ago quarter, mainly due to contribution from LNG developments in the Atlantic and Peru.
Downstream: In this segment, the Anglo-Dutch super-major recorded a profit (excluding one-time items) of $1.6 billion, reflecting a dramatic improvement from $558 million in the year-ago quarter. The considerable increase accounts for the impact of higher refining profitability, the company’s operating efficiency, and solid marketing and trading. To some extent, these factors were offset by lower Chemical earnings.
Cash Flow
During the quarter under review, the company generated cash flow from operations of $9.6 billion, returned $3.1 billion to shareholders through dividends/share buybacks and spent a net $7.8 billion on capital projects.
Balance Sheet
As of Dec 31, 2014, the company had $21.6 billion in cash and $45.5 billion in debt (including short-term debt). Net debt-to-capitalization ratio was approximately 12.2%.
Outlook
Shell is planning to curb capital expenditure by roughly $15 billion over the coming three years to cope with the free fall in crude oil price.
Other News
As per Nasser al-Esawi, Shell has entered into a deal with Iraq. Per the agreement, Shell is expected to spend roughly $11 billion on building a petrochemical plant in Iraq.
The plant is likely to start operating within the coming five to six years. Following the commencement of the plant’s operations, Iraq is anticipated to become the biggest producer of petrochemicals in the Middle East.
Shell Shuts Al Karaana Project due to High Capital Costs
On Jan 14, 2015, Royal Dutch Shell plc announced that it will not move ahead with the Al Karaana petrochemicals project and will suspend further works on it.
The project, a joint venture of Shell and Qatar Petroleum, was started in Dec 2011 with the signing of a Heads of Agreement (“HOA”) between the two. The companies had contemplated the construction a new world-scale petrochemical facility in the Ras Laffan Industrial City, north of Qatar. Shell has a 20% stake in the project while Qatar Petroleum holds the remaining.
The company added that the project has become commercially unfeasible with evaluations indicating high capital costs. The current weakness in the energy sector further supports this view.
The pricing environment of oil has been feeble for more than six months. In fact, the price of crude has plunged about 60% since June last year.
Shell to Divest Less Profitable Downstream Business in Norway
On Dec 18, 2014, Royal Dutch Shell plc entered into a deal with ST1 – an energy firm in Finland.
Per the deal, Shell will divest its Norway-based downstream businesses – which includes retail, commercial fuels, and supply and distribution logistics operations − for an undisclosed amount. The company added that it will share a 50:50 operation for its aviation business in that country with ST1. The divestment is dependent on approvals from regulators and will likely be closed in 2015.
Recently, Shell sold its downstream operations in Italy and Australia and also divested its UK, Germany, France, Norway and Czech Republic based refineries.
The sale reflects Shell’s intention to focus on a smaller numbers of downstream properties which the company believes hold competitive advantages.
VALUATION
Royal Dutch Shell’s current trailing 12-month earnings multiple is 8.6X, compared with the 8.6X industry average and 18.6X for the S&P 500. Over the last five years, Royal Dutch Shell’s ADRs have traded in a range of 6.9X to 15.9X trailing 12-month earnings.
Being one of the most gas-focused integrated companies in the world, Royal Dutch Shell is particularly susceptible to the commodity’s growing supply demand imbalance that is pressurizing prices. We are also concerned by the group’s high level of capital spending and the threat to its Nigerian operations.
This is corroborated by our continued Underperform recommendation. Our $56 target price, 11.2X 2015 EPADR, reflects this view.
Key Indicators
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of RDS.A. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1117 companies covered: Outperform - 15.8%, Neutral - 77.2%, Underperform – 6.4%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.