Even as oil prices see continued strength, the shares of Royal Dutch Shell (NYSE:RDS.A, RDS.B) haven’t, with shares down about 1% year-to-date against a 9% gain in the S&P 500. At around $72, RDS.B shares are around a six-month low.
It certainly did not help that the company posted a weak earnings report, including a drag from the refining business. Of course, this was the same for other giant operators like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX).
So is this an opportunity to pick up some shares of Shell at a good valuation? Let’s take a look at RDS’ pros and cons.:
Pros
Global Powerhouse: Shell has operations that span over 90 countries. It’s an integrated oil company that includes both upstream businesses, such as for exploration and development of energy projects, as well as downstream segments, which include refining, shipping and gas chains. Shell also has invested in alternative energy sources, such as wind power — the company has wind projects in both the U.S. and Europe.
Natural Gas: While Shell has extensive crude oil assets, the fact is that about 48% of overall production comes from natural gas. True, natural gas has come under downward pressure, which has crimped profits. Yet when looking at the long term, it has many benefits. Natural gas is much cleaner than traditional energy sources, and many natural gas resources are located in politically stable areas.
Dividend: RDS.B and RDS.A yield an attractive 4.7%. And in light of Shell’s strong balance sheet and cash flows, the dividend should not be in jeopardy of a cut.
Cons
Production: Even with new technologies — including deepwater drilling and tar sand harvesting — it is getting more difficult to find new sources of oil. And even when there new discoveries are made, the process requires huge investments. Companies also run the risk that governments might take out huge chunks in taxes — and perhaps even nationalize the assets. In the latest quarter, Shell saw a 5% drop in production to 3.3 million barrels of equivalent per day, with continued weakness in Europe and Africa.
Downstream Business: This also has been a drag on Shell. A big problem is the slim margins on the refining segment. As a result, the company has been aggressively cutting costs.
Oil Price Volatility: So far this year, oil prices have been strong. A key driver has been the continued instability in the Middle East, with Iran lobbing threats of closing the Strait of Hormuz in reaction to sanctions. Despite this, oil prices could be vulnerable to a fall. Tensions might ease in the Middle East, and there are signs of economic weakness in both Brazil and China, which also could put downward pressure on crude prices.
Verdict
Critical to Shell is finding new sources of energy. The good news is that Shell has proven exploration skills. It is a top player in deepwater drilling and also is strong with shale plays. Shell also continues to invest substantial amounts in its technology infrastructure.
The concentration on natural gas also should be a long-term boon, in terms of the growth potential and lower-risk profile.
Throw in RDS’ strong balance sheet and a hefty dividend, and the pros outweigh the cons.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.
