With Royal Dutch Shell, Size Really Matters

Sep.27.06 | About: Royal Dutch (RDS.A)

In 2004, Royal Dutch Shell PLC (NYSE:RDS.A) suffered some bad news when it had to revise its reserves downwards to a significant degree. Since then the company has been reorganizing to streamline decisions and improve accountability, and it has been working hard to improve its reserves situation.

In a different industry such bad news might have had more of an effect, but size really matters in the oil and gas business, and as the third largest oil company in the world, RDS benefited from its enormous size. The company has turned profits for years, even in years when revenues were down, and there doesn’t seem to be any reason to expect otherwise. Its balance sheet is extremely healthy with lots of cash on hand, which allows it to offer a healthy dividend and to engage in share buybacks.

The leadership under Jeroen van der Veer has been trying to cut costs and has eliminated stock-options to create longer term incentive plans that should make for a better balance of management and shareholder interests. The management shift occurred in the wake of the reserves embarrassment, so perhaps it had a silver lining.

To be sure, there are potential concerns. The company needs to improve its reserves situation, which may lead it to overpay for some acquisitions. Its exploration attempts are focusing on sketchy places in Africa and the Middle East, as well as Russia.

But I don’t think this company is going anywhere but up over time, and it’s all a question of getting in at the right discount.

Type of stock:
One of the largest oil companies in the world, in a business where size is virtually everything.

Price target: RDS is currently trading toward the lower end of its 52 week range, but the last month has been rough, with the share price losing $6 off its 52-week high. The sudden drop in oil prices is the culprit here. Those prices are going to go back up, but it’s not yet clear when. I think if you hold off a few weeks you might see this lose a bit more in its price, and it might be a good time to buy if it drops to around $61 or $62. You might see the price drop further for a bit, but it will still rebound at some point and it would be better to pick this up at a good discount than wait for the absolute bottom and then miss your chance.

RDS.A 1-yr Chart

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