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Royal Dutch Shell (RDS.A), one of the largest integrated oil and gas companies in the world, is increasing its exposure in LNG and shale gas, and at the same time is increasing its capital investment by 25%, which will ensure future growth. Fore these reasons, as well as its lucrative valuations and high dividend yields, we have a Positive stance on the stock.

Company Overview

RDS is an integrated oil and gas company, based in The Hague, Netherlands. The company has three business segments, namely Upstream (Exploration and Production (E&P)), Downstream (Refining and Marketing (R&M)) and Projects & Technology.

The Upstream segment has two divisions -- Upstream International and Upstream Americas. Overall, the segment is involved in the exploration and production of oil and natural gas, liquefaction and transportation of gas, and management of the midstream and upstream infrastructure required to transport the products to their respective markets.

The Downstream segment is involved in the refining, distribution and marketing activities of the company's oil and chemical products.

The Projects & Technology segment is involved in the delivery of the company's major projects, and is responsible for innovation and research, as well as creating technological solutions.

RDS has operations in more than 80 countries, employs about 90,000 employees, has about 48,000 retail service stations worldwide, and operates more than 30 refineries and chemical plants globally.

Financial Performance

Total revenues and net income for the company showed an increase in 2011 and 2010, as compared to 2009, due to the higher realized prices of oil and gas.

($) 2011

($) 2010

($) 2009

Total Revenue

470,171

368,056

278,188

YoY % change

28

32

-

Net Income

30,918

20,127

12,518

YoY % change

54

61

-

Diluted EPS

4.97

3.28

2.04

YoY % change

52

61

-

Upstream earnings increased by 53% in 2011, as compared to the previous year, due to the higher realized prices of oil and gas, higher LNG sales volumes, reduced impairment, and higher trading contributions. These factors were partially offset by lower production, higher operating costs (due to new projects) and higher taxes. Earnings increased by 91% in 2010, as compared to the previous year, due to higher realized prices, higher production, and gains on divestments.

Downstream earnings rose 45% in 2011, as compared to the previous period, due to lower operating expenses, higher chemical margins and an increased trading contribution (which was partly offset by a higher loss in refining and lower sales volumes). Earnings witnessed a 1,043% change in 2010, as compared to the previous year, due to increased sales volumes and refining margins.

$ Million

2011

2010

2009

Earnings by segment

Upstream

24,455

15,935

8,354

YoY % change

53

91

-

Downstream

4,289

2,950

258

YoY % change

45

1043

-

Corporate

86

91

1,310

YoY % change

-5

-93

-

Total

28,830

18,976

9,922

YoY % change

52

91

-

As the table above shows, the Upstream segment accounts for about 85% of RDS' earnings. The table below shows that RDS' revenue is geographically diversified, and that Europe is the largest revenue contributor.

(click image to enlarge)

Cash Flow, CAPEX and Dividend

Cash flow from operations increased by 34% and 27% in 2011 and 2010, respectively, as compared to the previous year, due to the increase in revenue and profitability. The CAPEX decreased by 2% in 2011, as compared to the previous year, and more than 80% was directed towards Upstream projects. The CAPEX increased by 2% in 2010, as compared to the previous year. Dividend payout decreased by 28% in 2011 and 9% in 2010, as compared to 2009. In 2011, the company returned $10.5 billion to shareholders through cash and shares (optional). RDS bought back 34.4 million shares to offset any dilution.

($) 2011

($) 2010

($) 2009

Cash flow from Operating Activities

36,771

27,350

21,488

YoY % change

34

27

-

CAPEX

(26,301)

(26,940)

(26,516)

YoY % change

-2

2

-

Dividends

(6,877)

(9,584)

(10,526)

YoY % change

-28

-9

-

Some Key Performing Indicators

($) 2011

($) 2010

Total shareholder return (TSR)

17.1%

17.0%

Project Delivery

79.0%

75.0%

Total production (thousand boe/d)

3,215

3,314

Refinery and Chemical plant utilization

91.2%

92.4%

Sale of LNG (million tons)

18.8

16.8

Proved oil and gas reserves (million boe)

14,250

14,249

The TSR and proven oil reserves are almost flat. There has been some improvement in project delivery, which is an indicator that RDS can complete its projects on time and within its budget. Refinery and chemical utilization declined as a result of deteriorating margins. Sales of LNG have shown an improvement due to increased demand. Divestments of 100,000 boe/d caused a slight drop in production.

Gas Production and Growth in Unconventional Production

Output from RDS' Upstream production is 48% natural gas, and the company is focusing on increasing its production. RDS is increasing its production of shale gas and LNG through CAPEX -- out of the 12 project undertaken by the company, four were for shale gas and two for LNG.

Oil Spill in Nigeria

Regulators in Nigeria have expressed their desire to fine RDS' local subsidiary an amount of $5 billion for the worst offshore spill witnessed, in a decade, in the oil rich country.

Outlook

As discussed above, RDS' profitability and revenues have increase over the last two years, primarily due to higher realized prices of oil and gas. We believe this trend will continue going forward, as gas prices in North America are expected to rebound in the future due to the declining trend witnessed over the last few years. RDS is also positioned to take advantage of high LNG prices being offered in Asia, due to increased demand from the energy-hungry region.

The company intends to follow an aggressive capital investment strategy, and is expected to increase capital investment to $30 billion in 2012, meaning an increase of 25%, as compared to $24 billion in 2011.

RDS trades at a cheaper P/E multiple of 7.9x as compared to its peers, and offers the highest dividend yield of 4.5%. Therefore, we have a Positive stance on the stock.

However, volatility in oil prices remains a key risk to our investment thesis.

Name

RIC

Est. P/E (X)

EPS ($)

DPS ($)

Div. Yield (%)

ROE (%)

P/Book

P/Sales

Royal Dutch Shell PLC

7.89

--

1.27

4.5

--

--

--

Exxon Mobil Corp

(XOM)

11.17

8.42

2.28

2.64

27.26

2.61

0.83

Chevron Corp

(CVX)

8.90

13.44

3.60

3.31

23.75

1.77

0.85

Occidental Petroleum Corp

(OXY)

12.43

--

2.16

2.48

--

--

--

Sector average (Mean)

--

10.35

10.93

n/a

2.57

25.51

2.19

0.84

Sector median

--

11.17

13.44

n/a

2.54

27.26

2.61

0.85

Source: Shell's Lucrative Valuations, High Dividend Yields Make It An Attractive Stock