This article will focus on two energy companies, Chevron Corporation (CVX) and Royal Dutch Shell Plc (RDS.A), and detail the attractiveness of each investment option. The goal of this article is to provide readers with the reasons of choosing one over the other. Oil and gas companies are historically dividend paying companies with solid cash flows and cash reserves. A diversified portfolio should certainly have some energy exposure. In looking to find the right stock, RDS.A and CVX are two major players in this space that attract attention.
First, let us look at RDS.A, which an independent oil and gas company with headquarters in the U.K. and the Netherlands. Currently, the stock trades at $64.62 with a PE ratio around 8 and annual yield of around 5.3%. Year to date the stock is down over 6%, and over the past 52 weeks is down just under 6%.
The company's performance over the last year has been mixed. According to the 2012 annual report, fourth quarter earnings were $7.3 billion, compared to $6.5 billion in the fourth quarter of 2011. I also like the Shell raised its dividend by 4.7% to start off 2012. However, comparing full year performance of '12 to '11 paints a cloudier picture. Full year earnings for RDS.A for 2012 was $27 billion, compared to $28.6 billion in 2011, a decrease of 5.5%. A few other metrics point to areas of concern. The 4th quarter of 2012 performed lower when compared year as a whole, which does not bode well going into 2013. Net profit margin, return on average equity, and return on average assets were all down in the 4th quarter compared to the year as a whole. Also, 2012 was a tough year compared to 2011, which should not logically be the case since the market rebounded sharply, oil prices were rising, and economies around the world were growing. Earnings, after taxes, for 2012 of $28.6 billion compares to 2011 earnings of $31.18 billion, a decrease of 14%.
The reasons for the decline are stated in RDS.A's annual report of increased operating expenses, higher depreciation, and higher exploration expenses. Given that the price of oil has been declining throughout 2013 and the costs for extracting new sources of oil from the earth is only going to get more costly as the supply becomes more and more depleted, I have to conclude that this trend of lower revenue and higher costs will continue into this year for RDS.A. With a solid dividend and a beta of .96, just under the market as a whole, RDS.A is certainly not a overly risky play, but I would search for better alternatives.
Another reason why I am lukewarm about RDS.A is because of its location in Europe. While it is an international company, RDS.A is going to be affected more than CVX if the EU rewrites any tax laws or hikes the corporate profit tax. While Northern Europe has held up well, the U.K. is facing a tough election cycle and struggling growth. Southern Europe as a whole is still causing problems and that can be a drag on the whole region. I do not expect these issues to go away at any point this year, so I am looking for stocks and funds that have limited European exposure. A company based in Europe that generates a significant amount revenue and sales volume there (about 1/3 in 2012), does not fit my criteria.
One alternative is CVX and I will compare some of these same metrics to RDS.A to see if it makes more sense to own. CVX is currently trading at $116.57 with an annual yield at 3%. Year to date the stock is up just under 8%, and over the past 52 weeks the stock is up almost 14%, excluding dividends. Past performance alone almost compels me to buy CVX over RDS.A, but I will examine further. Quarter 4 of 2012 was actually more profitable for CVX than the average for the year, a much more promising picture when compared to RDS.A. CVX's net profit margin was over 1% higher in the 4th quarter than the average for the year, and return on average assets and return on average equity were up .83% and 1.27%, respectively.
However, some other metrics point to a mixed review of CVX as well. CVX cites higher exploration expenses and higher labor costs as a reason why expenses were up over $1 billion in 2012 compared to 2011. While this is not necessarily a negative, revenues were down during the year over year period, sales and other operation revenue was (in millions) $230,590 in 2012 compared to $244,371 in 2011. However, the 2012 annual report does show an increase in cash and cash equivalents of $5 billion. If CVX can put this additional cash reserve to work, either by distributing it to shareholders or by increasing exploration, this could greatly benefit shareholders over the coming years.
The trend among U.S. companies over the past year and a half has been to increase dividends. I would look for CVX to do with this amount of cash on hand. This could definitely serve as a catalyst for the stock to move higher.
A negative about CVX is its exposure to OPEC countries. While the OPEC region is a growing emerging market that can be very profitable when times are good, this is a region that is subject to enormous political and social risks. According to CVX's 2012 annual report, 21% of the company's net reserves were in OPEC countries. If tensions flare up in the region, and they almost certainly will at some point in the next few years, this could harm CVX's ability to get its product out of the region and to the market.
Bottom line: I like the idea of owning CVX right now, compared to RDS.A because it has a stronger recent performance and has better financial metrics. Also, oil and gas prices are at unusual seasonal lows. If there is an uptick in gas prices heading into the summer, which I anticipate because that usually happens, energy companies' stock typically rise in value along with the price of oil. Additionally, CVX fits my bill with a yield exceeding 3%, which is the benchmark I use when looking for dividend paying stocks or ETFs. While the price of oil is highly speculative, and thus causes energy companies to be more volatile than other companies of similar size, CVX has a beta of .78 which signals it is less volatile than the market as a whole. This makes it a more attractive option, in my opinion, because it should decrease at a slower pace than RDS.A if the market takes a dive. While neither one of these stocks is a "sure thing", I truly believe it is imperative to have some energy exposure in every portfolio. I believe CVX will perform better in the near and long term than RDS.A, so I do not think it wise to chase RDS.A's higher yield at this time.