Royal Dutch Shell: Will The Big Bet On Natural Gas Pay Off?

| About: Royal Dutch (RDS.A)

Summary

Royal Dutch Shell: a closer look into year-to-date trading performance and thoughts on valuation.

Large-cap energy sector ends with $73.1 billion market value loss by close of business Friday.

Key EPS and dividend data presented for top 20 underperformers in the energy sector.

Welcome to the energy sector's eleventh edition of "Buy on Weakness?", a series of articles that sifts through the underperformers of the week to find potential investment opportunities in the large-cap energy world.

Credit: DM Martins Research montage using company logos

The idea is to help investors, particularly those focused on value plays, unearth ideas for the coming week. Check out the tenth and ninth editions of "Buy on Weakness?" for a look into prior weeks' "energy losers".

The table below highlights the top 20 energy companies - worth $10 billion or more in total equity value - that have performed the poorest in the previous five trading days.

Order

Symbol

Company Name

Security Price

Market Cap (billions)

Price Perf. (5 Days)

1

EC

ECOPETROL- ADR

$8.55

$17.6

-7.7%

2

RDS.A

ROYAL DTCH SH-A

$51.79

$207.7

-6.0%

3

RDS.B

ROYAL DTCH SH-B

$54.21

$217.4

-5.7%

4

STO

STATOIL ASA-ADR

15.91

$50.7

-5.6%

5

XOM

EXXON MOBIL CRP

$88.95

$368.8

-5.4%

6

CEO

CNOOC LTD ADR

$120.39

$53.8

-5.2%

7

CNQ

CDN NTRL RSRCS

$30.23

$33.2

-4.4%

8

KMI

KINDER MORGAN

$20.33

$45.4

-4.2%

9

BP

BP PLC

$34.40

$106.8

-4.1%

10

PAA

PLAINS ALL AMER

$27.86

$11.1

-4.0%

11

OKS

ONEOK PARTNERS

$40.23

$11.5

-3.9%

12

SSL

SASOL LTD -ADR

$26.69

$17.4

-3.9%

13

MPLX

MPLX LP

$32.45

$10.8

-3.9%

14

SGTZY

SURGUTNEFTEGAZ

$4.72

$16.8

-3.8%

15

EPD

ENTERPRISE PROD

$28.47

$59.3

-3.6%

16

IMO

IMPERIAL OIL LT

$30.69

$26.0

-3.5%

17

MRO

MARATHON OIL CP

$13.64

$11.6

-3.3%

18

REPYY

REPSOL SA-ADR

$12.62

$18.2

-3.3%

19

CVX

CHEVRON CORP

$102.48

$193.1

-3.0%

20

EQT

EQT CORP

$72.86

$12.6

-2.9%

Click to enlarge

Source: DM Martins Research, using market data compiled by Zacks Research

Supply Glut Continues to take its toll on Oil Price

Oil continued its downward pressure amid a supply glut, with WTI Crude oil getting close to the $40 mark, ending July with the worst monthly loss in almost a year. S&P Energy was down 1.7% for the week while Dow and S&P were down 0.8% and 0.1% respectively. Large-cap energy group was down 2.3%, or ~$73.1 billion in market value this week. Biggest decliner in large-cap energy this week was Ecopetrol - ADR (NYSE:EC), down 7.7% this week, while the biggest gainer was Baker Hughes (NYSE:BHI), up 7.4%. Overall in the portfolio of 67 large-cap energy stocks that we analyzed, there were 41 with negative performance over the past 5 trading days.

Source: Google Finance

WTI Crude was down 6.5% in the same week, closing at $41.36. Natural gas futures started the week down 2.5% before rallying 8% on Thursday, ending the week up ~5.7%, closing at $2.88.

Let's take a closer look at some metrics focusing on the weeks' top 20 underperformers in the energy space.

Diving deeper into the data

The top 20 energy losers of the week have a low median 2017 forward P/E of 17.2x, compared to the S&P 500's median trailing P/E of 14.6x. This week's top 20 group is expected to grow EPS in 2017 by 85.8%, and the companies generate median dividend yield of 4.3% (19 out of 20 companies are dividend-payers).

The table below highlights, in green font, the three best-positioned energy companies in each of the following categories: projected EPS growth, dividend yield, 2016 forward P/E and 2016 forward PEG (P/E divided by percentage-point EPS growth).

Click to enlarge

Source: DM Martins Research, using data from Yahoo Finance, Nasdaq and Market Watch

So which short-term loser should investors consider adding to their portfolio to take advantage, in the long run, of the price pullback? Let's take a closer look at one potential opportunity featured on energy's top 20 "biggest loser" list last week.

After the BG acquisition earlier this year, Royal Dutch Shell (NYSE:RDS.A)(RDS.B) has significant strengthen its natural gas reserves to becoming the largest producer of liquefied natural gas in the world.

Trading Recap:

As of close of business on July 29nd, Royal Dutch Shell (NYSE:RDS.B) was up 13% YTD, barely edging benchmark results for the energy sector SPDR (NYSEARCA:XLE), at 11.7%:

Click to enlarge

Source: Google Finance

Despite the recent drop in stock price after Q2 announcement, we have a bull stance on the company:

- Royal Dutch Shell is the largest producer of LNG (Liquefied Natural Gas), accounting for over half of the company's revenue in Q2 2016. With the recent natural gas rally on the back of smaller-than-expected weekly inventory climb in the U.S., we believe Royal Dutch Shell is position to take advantage of the higher price. According to an article on WSJ, Kent Bayazitoglu argued the day of excessive inventory for natural gas is over, leading to a stronger outlook going forward.

- Royal Dutch Shell owns a strong and diversified portfolio of global energy businesses, which we believe will help drive long-term growth as commodities price recovers. The company has further solidified its position with the recent BG acquisition, which helps increase the company's oil reserve by over 25%.

Risks:

- BG acquisition has increased Royal Dutch Shell's net debt position and reduced its liquidity. Despite the company's announcement after Q2 to maintain the dividend level, we remain concern over liquidity constraints that might force the company to revisit its dividend payout policy.

- Company is exposed to significant operations headwinds in Africa, with terrorists disrupting Nigeria oil and gas pipelines.

Royal Dutch Shell's acquisition of BG is contingent on oil price going up to mid-$60s a barrel for the transaction to be profitable. Given the recent supply glut and gloomy outlook published by EIA, we believe the possibility of oil reaching the target price is not likely in the near future.

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

Business relationship disclosure: Report authored by Jay Yang, edited by Daniel Martins