In an environment of volatile oil prices, integrated oil companies benefit from their defensive character because their earnings and share prices have a relatively low correlation to the oil price movement (compared to other energy companies). While oil prices remain volatile and investors are debating at which speed the global economic recovery will continue to proceed, companies such as Royal Dutch Shell (NYSE:RDS.A) still provide a downside hedge against future oil price weakness. In this context, RDS provides an interesting combination of low valuation with a high dividend yield.
The company comes with a growth "option" that is primarily based on two mega projects in Qatar (Pearl Gas-to-Liquids and Qatar 4 LNG) and on long-life projects in the Americas (oil sands, deepwater and unconventional gas). These 25-year long-term projects in Qatar and in the Americas can deliver more predictable future production growth across the whole commodity price cycle and will "de-risk" the company's resource base.
RDS reported an 18% year-over-year increase in clean net profit (after inventory revaluations and exceptional items) to USD 4.8 bln in Q4 2011. The profit miss came from a weaker-than-expected result in the Refining & Marketing division, which reported a USD 278 clean net loss after a USD 482 mln net gain a year ago (due to significantly weaker refining margins and less refining volumes). In contrast, clean net earnings in the Exploration & Production (E&P) division jumped year-over-year by 48% to USD 5.1 bln, which was entirely driven by higher oil prices as production volumes fell year-over-year by 5.5% to 3.3 mln boe/day (partly due to asset disposals). However, output has started to pickup sequentially quite strongly by 9.7% from Q3 2010.
RDS has completed asset disposals of roughly USD 6.2 bln in 2011 and confirmed capex spending of USD 30 bln at the upper end of expectations in 2011. RDS also re-iterated that first gas production from QatarGas 4 LNG and Pearl GTL started in 2011. As the recent trend of strong production growth should be sustainable in 2012 due to the start-up of its legacy projects in Qatar, our underlying investment case remains valid that RDS should deliver sector-leading production growth in coming quarters, which will de-risk its production profile by generating steady output and strong cash flow.
As RDS has a relatively high earnings exposure to the Refining & Marketing business, the seasonally Q4 refining weakness has put more pressure on Q4 result in 2011. In contrast, the company's strategic shift into higher priced Asian LNG will help to offset weak natgas prices in the US and in Europe. While RDS left its Q4 dividend unchanged at USD 0.42/share, the company guided for a dividend increase to USD 0.43/share in Q1 2012. The strong sequential production increase should be seen as an indication that the company will deliver production growth from its unconventional legacy projects in 2012 (Qatar's LNG and Pearl GTL projects as well as oil sands in Canada). Despite today's refining disappointment, the stock's defensiveness and high yield (more than 5%) are solid rocks in an uncertain investment climate.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.