Royal Dutch Shell - Divesting More Of Woodside, Yet Shares Offer Little Appeal

Jun.17.14 | About: Royal Dutch (RDS.A)


Shell is shedding non-core assets like any oil major, this time it sells a 19% stake in Woodside for $5 billion after-tax.

This comes after the company had a rough start to this year and divested Eagle Ford assets last month.

Increased leverage, lower production and a demanding valuation based on current earnings creates little appeal.

Investors are largely drawn to the amazing dividend track record and high current yield.

Royal Dutch Shell (NYSE:RDS.A) announced that the company has finally reached a deal to sell the vast majority of its stake held in Australian-based Woodside Petroleum.

The divestment is sizable, and complements the plan to focus on core assets. That being said, the company continues to struggle with a fall in production, increase in leverage, and short-term earnings being hit by various charges.

The Deal Highlights

Royal Dutch Shell announced that is has sold roughly 165.5 million shares in Woodside Petroleum (OTCPK:WOPEY), generating proceeds of roughly $5.0 billion on an after-tax basis for the company.

The sale involves roughly 19.0% of Woodside's equity capital. Under the terms of the sale, Shell will sell its shares in an underwritten sale to the market, as well as to Woodside, which is executing a buyback program.

Shell's SEHAL subsidiary has set a mandate with two banks to sell 78.3 million shares in Woodside at AUD 41.35 per share, which in their turn, sell shares in the wider market. Woodside will buy a similar quantity of shares from SEHAL at AUD 34.34 per share.

Note that shares of Woodside ended the trading session at AUD 42.85 per share, trading at the highest levels since the first half of 2011. The sale to the general market and buyback program are anticipated to be closed in June and August of this year, respectively.

Rationale For The Sale

Woodside has been on Shell's radar for a long time, after the company tried to acquire the Australian company back in 2001. This deal was essentially held back by the Australian government. After the failed attempt, the 23.1% holding of Shell in the company has long been regarded as a non-core asset. Following the completion of the deal, Shell's investment in Woodside will be diminished to roughly 4.5% of shares outstanding.

CEO Ben van Beurden stresses the rationale as Shell seeks to improve capital efficiency and growth through directly-owned assets. The company continues to be committed to Australia as an important place to invest and conduct business in the future.

Soft Start To The Year

At the end of April, Shell reported its first-quarter results. The company posted earnings on a current cost of supplies basis of $4.5 billion, which was down sharply from a reported $8.0 billion the year before. The main reason for the earnings fall were $2.9 billion in charges related to predominantly impairments on European and Asian refineries.

Excluding these items, earnings were down just 3% to $7.3 billion. This is remarkable given the fact that total oil-equivalent production was down 9% to 3.24 million barrels per day. Divestments, continued struggles in Nigeria, and the NAM curtailment in the Netherlands impacted results.

With Shell's ADRs trading at $81 per share, the company is valued at $257 billion. Note that the company has access to nearly $12 billion in cash and equivalents, but it does hold almost $46 billion in total debt.

The company has posted trailing annual revenues of $456.2 billion, on which it posted earnings of a "paltry" $12.7 billion. This values equity at almost 0.6 times annual revenues and 20 times earnings.

The ADR's quarterly dividend of $0.94 per share provides investors with a 4.7% dividend yield.

Implications For Investors

Shell has been embarking on a more focused strategy, just like its competing players in the entire energy sector. The sale of the Woodside stake is part of this strategic direction. Just last month, Shell announced the sale of Eagle Ford acreage in a $639 million deal with Sanchez Energy (NYSE:SN).

Despite showing very volatile results, Shell has historically grown its business in the long term. Between 2004 and 2013, Shell has increased annual revenues at a compounded rate of roughly 6%, boosting revenues from $266 billion to $460 billion. Earnings have been very volatile, coming in as low as $12 billion on a trailing basis at the moment and back in 2009. In comparison, the company posted record earnings of $31 billion in 2011.

Besides large moves in oil prices, incidental items typically have had a large impact on the company's earnings. A $40 billion annual capital expenditure program, much higher than depreciation and amortization charges of $25 billion, drains free cash flows at these low earnings levels. As such, leverage is on the increase, as Shell wishes to please investors with a compelling dividend yield as well, costing the company about $15 billion per annum.

As a result, leverage has been on a steady increase, while production continues to fall. This, combined with the already steep valuation on historically low earnings makes me worried. There are still better-quality oil majors out there at 10-12 times earnings, and I doubt that Shell can quickly recover to $20-$25 billion in annual earnings, while showing an improved production profile.

For that reason, I remain on the sidelines. The recent momentum, which has pushed shares to already return 13% this year, provides an excellent point to take profits.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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