Is Royal Dutch Shell A Buy?
The oil sector is being slammed by the massive drop in price for oil over the last 8 months, leading to some of the largest oil companies shares tanking in value on their earnings being compressed. Royal Dutch Sell is a diversified operating structure that consist of exploration, extraction, refining, chemicals, and distribution or retail sales. This diversified operating structure is designed to shield investors in Royal Dutch Shell from the cycle of the price of oil. Price of oil per barrel has a habit of spiking in price and falling to unprofitable levels. Royal Dutch Sell can survive if its has to with $40 barrel oil.
I believe that rational long-term investors should use the collapse in oil price to load up on shares of Royal Dutch Shell and take advantage of averaging down. The company will be able to maintain its profits at a lower price per barrel due its its economic scale. Royal Dutch Shell will see its margins compress and its profits from its refining segment will fall. The company was supposed to produce $12 billion in profits this year, however that isn't going to happen with oil selling for $45 per barrel. Even with oil selling below $50 dollars a barrel, Royal Dutch Shell is expected to produce $14 billion in earnings this year.
The company's downstream segment has been propping up its earnings, but this is starting to decline. Low global demand for oil will begin to compress Royal Dutch Shell's downstream segment. The company will start seeing lower profits from its downstream segment. This will lead to the company not producing $14 billion in earnings this year. I believe that the company will probably produce $8 billion in 2015.
Since the company has already cut to the bone, Royal Dutch Shell won't be able to prop up its earnings through cost cutting. The company has laid off 6,500 employees since the oil glut began, and has done other things to lower their cost. Lowering operating cost has temporarily put a floor under its earnings. This floor isn't going to last much longer and its recent $70 billion acquisition will cause investors to worry, which will lead to shares falling below $50/share.
In April of this year, Royal Dutch Shell announced plans to acquire BG Group for $70 billion, a global oil and gas company with a large liquefied natural gas segment. BG Group is the largest provider of liquefied natural gas to the United States. When the deal is finalized, BG Group shareholders will own 19% of the combined group. When combine as one company Royal Dutch Shell will be the largest producer of liquefied natural gas in the world. This will provide the company a large source of revenue and earnings to balance out its oil segments.
Royal Dutch Shell reported its second quarter results of $3.3 billion in earnings compared to $5 billion in the previous quarter last year. The company's earnings per share decreased 33% from the previous quarter last year. Royal Dutch Shell had cash flow of $6.1 billion compared to $8.3 billion in the previous quarter last year. During the second quarter, Royal Dutch Shell distributed $3.0 billion in dividend or $0.47 in ordinary shares and $0.96 in ADRs.
If oil stays at $40 per barrel for the next five years than Royal Dutch Shell may be overvalued $50/share. Nevertheless, it's how you look at the company; if you're seeking to hold a position for 5 years then you shouldn't invest in Royal Dutch Shell, but if you plan on holding the position for the next 10 years, then its a buy.
Posted in ...Market Commentary