Royal Dutch Shell (RDS.A) had a challenging third quarter. Earnings came in at $4.5 billion vs. $6.6 billion in Q3 2012 (a decrease of 32% y-o-y). Results were mainly impacted by higher exploration and maintenance charges as well as declining refinery margins. Declining refinery margins have impacted quite a few oil- and gas companies as well as their spun off refinery businesses over the last two quarters. I have previously argued that I think refinery margins will recover due to the extraordinary demand for storage- and refinery capacity which is driven by an unprecedented boom in oil- and gas production in the US.
Trailing twelve month share performance
Royal Dutch Shell presently trades at $67.70 and about 7% below its 52-week High at $72.99. Although RDS.A trades close to its twelve month High it only returned 0.21% over the last year.
When compared to other large-cap energy concerns, Royal Dutch Shell received the red light over the most recent two-year period. Shell's peer group consists of BP (BP), Total (TOT), Chevron (CVX), Exxon Mobil (XOM) and ConocoPhillips (COP).
I don't see any reasons why Royal Dutch Shell couldn't catch up in terms of valuation and present a better performance in the coming years. In fact, Shell's valuation metrics are one of the most attractive in the sector.
Long-term demand drivers favorable
I believe the market overemphasizes current uncertainty with respect to declining refinery margins. In addition, Shell's Q3 2013 results were impacted by security issues at its Nigerian operations which impacted results by about $300 million. All these issues are short-term in nature and investors are better advised to look at the long-term supply/demand dynamics that ultimately determine the attractiveness of a Shell investment.
Oil- and gas resources are harder to find than ever and discovered reservoirs are becoming progressively more difficult to exploit. At the same time, global growth will pick up steam going forward and will revert to its long-term mean of 3-4%. Unregulated, fast-growing emerging market economies (Asia, Latin America and Africa) will drive energy demand in the coming decades. Both population growth and an increase in energy per capita consumption in emerging markets will favor global oil- and gas players like Royal Dutch Shell. Investors can now grab a diversified oil- and gas company like Shell at a sizable margin of safety.
When it comes to energy companies I place a lot of emphasis on peer group comparisons. Royal Dutch Shell is undeservedly lagging in performance which makes it an attractive BUY candidate by itself. Royal Dutch Shell's earnings valuation is extremely attractive (and I think RDS.A rivals BP in terms of value proposition): First, the company trades at less than 9x forward earnings which translates into an earnings yield of more than 11%. Secondly, its P/E ratio is the second-lowest after Total which has a ratio of 8.70. BP, another large-cap oil- and gas play with extraordinary rebound potential due to misjudged settlement risk, trades in the same valuation range: It has a P/E ratio of just 9.04.
Royal Dutch Shell does not only have one of the lowest P/E multiples but it also has one of the highest dividend yields in the large-cap oil- and gas sector. The company easily holds up to BP and Total which also have above-average dividend yields. Interestingly, it is the high-yielding firms in the peer group which possess the largest capital appreciation potential.
The following table compares large-cap oil- and gas players in terms of market capitalization, earnings valuation, PEG value (if applicable) and dividend yield.
Royal Dutch Shell, like other companies with significant refinery operations, was hit by an industry-wide trend of declining refinery margins in the third quarter. I think that the oil and gas sector, especially in the US, will exhibit buoyant momentum over the coming years as the US is becoming energy independent as its exploration sector experiences an unprecedented production boom.
Royal Dutch Shell has an attractive pipeline of global development projects including Carmon Creek in Canada and Libra in Brazil. Shell's valuation is very low at a P/E ratio of just 9x forward earnings and its dividend yield is outstanding at over 5%. Shell could be an investment option for investors who desire a lowly valued, global energy player with ambitions to acquire new oil- and gas assets aggressively (the company announced $10 billion worth of acquisitions in 2013). Long-term BUY.