Quarterly Results and the Future Ahead
Shell's earnings were indeed very poor. At $4.5 billion or $1.42 per ADS, they were 15% below consensus estimates. Earnings were down by 32% year-over-year and 2% sequentially. Poor results could be explained mainly by higher exploration and operating expenses, production disruptions in Nigeria, and weak refining results. That said, the company is firmly investing to boost its future production capabilities. The company has $149 billion of capital tied up in new projects which are expected to generate operating cash flow of over $170 billion if Brent crude trades above $80.
Given the new projects that should become productive, 2014 should be a better year. Shell has started up several new oil and gas projects that should become fully productive as soon as next year, including deep water Brazil and integrated gas in Australia and Iraq. As a matter of fact, the company expects the largest five of the new projects to be able to add more than $4 billion of operating cash flow as soon as 2015. Consistent with its investment plan of $120 billion to $130 billion, 2014 and 2015 will include a portfolio clean up of around $15 billion, potentially freeing up substantial cash that would be available for higher margin ventures such as LNG projects, a market where Shell is currently a world leader.
Valuation Looks Cheap
Royal Dutch Shell offers a 5.5% dividend yield (the highest in its sector) which is covered by the company's estimated 4.9% 2015 FCF. In addition, the company aims to keep on increasing its cash dividend at a 3% to 4% year-over-year pace. Its important to mention that – unlike most of its peers – Shell hasn't cut its dividend in more than 70 years.
The Anglo-Dutch oil major trades at 8 times 2014 P/E and 4.8 times 2014 EV/EBITDAX which is significantly below peer averages. For example ExxonMobil (NYSE:XOM) sells for 12 times 2014 P/E and 7.7 times 2014 EV/EBITDAX. On the other hand, Chevron (NYSE:CVX), which is also investing heavily and is expected to increase production fast, sells for 10.1 times 2014 P/E and 5.6 times 2014 EV/EBITDAX.
Despite having gone through a poor quarter, Shell's shares should out-perform hand in hand with the company's production ramp-up. The shares have declined by 4% this year, compared with a gain of 6% for the peer average and 26% for the S&P 500. That said, such a trend should be about to be reversed. I would start looking closely at Shell's shares.