Investors Don't Care About Shell's Short-Term Troubles

| About: Royal Dutch (RDS.A)

Last week, Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B), issued an update and a warning regarding the last quarter. According to the update, the company will be missing its guidance and analyst estimates greatly for the fourth quarter and full-year of 2013. The company said that its quarterly profit would fall from $7.3 billion to $2.2 billion between the fourth quarter of 2012 and the fourth quarter of 2013, while the net profit for the full-year would fall from $27.2 billion to $16.8 billion. This is a sharp decline and affects the company's valuation strongly.

The warning didn't really make much of a difference for the investors who continued to hold onto their shares. In the day following the guidance, the share price of Royal Dutch Shell was down by only about 1%.

Shell mainly blamed its troubles on low gas and oil prices. The company posted declines in both upstream (down from $20.1 billion to $15.1 billion for the full-year and from $4.4 billion to $2.5 billion for the fourth quarter) and downstream (down from $5.4 billion to $4.5 billion for the full-year and from $1.2 billion to $0.5 billion for the fourth quarter). While the company's cash flow from operations fell from $46.1 billion to $40.4 billion, its net capital investment rose significantly from $29.8 billion to $44.3 billion.

While upstream volumes are falling, exploration costs are getting higher and the company had trouble managing its capital during the quarter. Currently, Royal Dutch Shell is busy with selling assets and collecting money from these sales in order to become leaner and meaner. The company hopes to focus on fewer projects that are more profitable rather than focusing on many projects some of which are not profitable. The company targets a divestment plan of $15 billion in 2014 and 2015, which includes sales of assets in Black Sea, Western Australia and Africa. The company will be also selling some of its refinery businesses, which didn't prove to be very profitable.

In the earlier part of the year, Shell had to write down $2.2 billion in gas assets in addition to the well-known troubles in Nigeria. This also affected the company's profitability greatly. Even though the company had trouble increasing its volume for almost a decade, it still remained highly profitable and it was able to raise its dividends due to the strength of the oil prices. Once the oil prices started to weaken, the weaknesses in the company's books started to appear clearer than ever. Shell is currently working harder than ever on increasing its production volume to meaningful levels, but this has proved too costly for the company as it ramped up the company's expenses big time. Shell is trying to increase its presence in the unconventional oil business in an effort to increase its volume but this is much riskier than the conventional oil in terms of both financials and difficulty of execution. The company is also suffering big time from its refinery business as the margins are getting thinner and thinner.

As the rate of unconventional oil projects in Shell's overall portfolio keep growing (currently at about one third), the company will have to rely on high oil prices to sustain its profitability. Since unconventional oil is more expensive and more difficult to produce, it takes higher oil prices to justify many of these projects. On the other hand, the conventional oil reserves keep declining and many of these reserves are already claimed by oil companies around the world. Some may say that "the easy money is already made in the oil industry" but we will see whether this is true or not. The technology around the oil industry is developing rapidly, and it is only a matter of time before much of the unconventional oil becomes "conventional" for major oil companies.

In the last 5 years, Shell's shares have been up by only 39% whereas the S&P 500 index has been up by 106% during the same period. Year-to-year, Shell is pretty flat. For the last few years, for many investors, Shell has been mostly about dividends because the company is one of the few giant oil companies that yield more than 4%, a much better yield than companies like ExxonMobil (NYSE:XOM) whose yield is usually around 2-3%. As long as Shell doesn't announce a cut in dividends, investors will not be selling this company off. This is why we didn't see much of a decline in the company's share price when it announced that it would miss the estimates by about 30%.

Given the new guidance, the company's P/E ratio will rise sharply from 11 to 14. This compares with Exxon's 13, Statoil's 13, Total's 11, Chevron's 10, ConocoPhillips' 10 and BP's 6. I don't really expect Shell's share price to move much in either direction anytime soon unless the company announces something drastic with its dividends (a sharp increase, sharp cut or suspension of dividend payments which is very unlikely). Shell will continue to attract dividend investors as it always has and the company's share price will not be affected much by short-term troubles.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.