Why Not Consider This Undervalued Oil Player With A 4.70% Yield For The Long-Term?

Oct.28.13 | About: Royal Dutch (RDS.A)

Oil business is good business. Once a company has discovered a promising oil- or gas reservoir, well lives usually range in the decades. The market price for crude oil remains high around the $100 mark and supports oil majors with diversified energy sources like Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B). On October 21, 2013 Royal Dutch Shell announced that:

A consortium of companies, including Royal Dutch Shell plc, Petrobras (NYSE:PZE), Total (NYSE:TOT), CNPC and CNOOC (NYSE:CEO), won today a 35-year production sharing contract to develop the giant Libra pre-salt oil discovery located in the Santos Basin, offshore Brazil.

Large new discoveries are rare and it is a big positive for Shell shareholders that the company got a big foot in the door offshore Brazil. I am also quite optimistic about future oil demand from the industrial sector and from the expanding consumer base in Asia. Once China has overcome its real estate hiccup, the country will likely drive future global growth. A strengthening economic environment should be favorable for crude oil- and gas prices and for shareholders of Royal Dutch Shell as well.

Share performance

Royal Dutch Shell has upside potential not only because of depressed valuations in the oil sector but also because its shares have relatively underperformed major peers over the last year. Royal Dutch Shell just managed to break-even this year with a tiny plus of 0.51%. BP (NYSE:BP), which is busy with itself due to oil spill related litigation, has returned 2%. Exxon Mobil (NYSE:XOM), the large oil major with a market capitalization of $390 billion, was the worst one-year performer with a minus of 3.51%. Chevron (NYSE:CVX) is up 9% and Total 22%.

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Interesting new developments

It is important for oil- and gas exploration companies to secure future commodity flow and keep the pipeline filled with new projects. New discoveries, particularly offshore, are rare and require substantial capital outlays. Shell plans to put down $120-130 billion in investments from 2012-2015. Shell also estimates it will achieve operating cash flow of $175-200 billion during the same period billion giving the company potentially up to $80 billion for debt reduction and shareholder remuneration. An overview of Shell's key development assets is provided below:

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What also is a big positive is that Shell has strengthened its footprint in the U.S. shale landscape. The purchase of Chesapeake's (NYSE:CHK) Permian Basin liquids-rich shale assets in West Texas back in 2012 was certainly the right step. I think it is also important for any oil company to concentrate on a set of promising shale portfolio assets rather than work the entire shale landscape in the United States. Shell's intention to focus on fewer shale plays will likely support cash flow growth and drive shareholder value in the long-run.

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Market valuation

Besides the attractive development portfolio and a reshaping of its North American shale gas footprint, Shell's valuation and dividend metrics were the most convincing reason I put a few 100 shares into my retirement portfolio. First off, the shares are dirt cheap, compared to peers but also compared to Shells quality exploration assets and cash flow strength.

Royal Dutch Shell trades at 8.84 forward earnings which is slightly more than Total's 8.80. BP trades at 8.38 and also is clear BUY candidate for investors with a contrarian touch. Exxon Mobil and Chevron are the only companies trading above the peer group average of 9.39. Neither Exxon nor Chevron are expensive but Royal Dutch Shell and BP offer investors a better risk/reward ratio and more upside potential. Their low valuations and high dividend yields make them great additions for any income-oriented portfolio for investors who aren't up for trading-in and trading-out.

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Royal Dutch Shell offers investors a 4.70% dividend yield which is only surpassed by BP's 4.95%. The oil- and gas sector, including MLP's, pays one of the highest yields in the field.

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Royal Dutch Shell is one of the most attractive large-cap oil companies for investors to grasp. Its forward P/E at 8.84 is low (earnings yield of 11.3%) and Shell is about 6% cheaper than the average oil producing company. It also pays the second highest dividend yield at 4.70% only second to BP at 4.95%. With an average peer group forward P/E of 9.39 the large-cap oil sector remains significantly undervalued as a whole.

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Summary

Investors who seek exposure to the oil- and gas sector should consider Europe's largest oil company with its interesting development portfolio and first-class access to North American shale assets. Oil prices remain strong and a rebound in economic activity in China and the U.S. is likely to work as a catalyst for higher oil prices. Royal Dutch Shell can also be purchased at a very attractive entry price of only 9 times forward earnings. Dividend investors who seek long-term income streams get to enjoy a 4.70% dividend yield which is one of the highest in the sector and higher than most corporate bond yields.

Disclosure: I am long BP, RDS.A. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.