Shell and the Clean Up Theory

Since early October 2013, Shell's (RDS.A) shares have risen nicely from $65.5 to today's $70.5 per share. Investors were expecting the company's new restructuring plans to start yielding results into the 2014/2015 period. That said, last quarterly results were extremely disappointing. As a matter of fact, even after excluding asset write downs (such as dry holes in the French Guiana), fourth quarter earnings came at around $2.9 billion, a figure which was well below the $4 billion Mr. Market was expecting. Nevertheless, its possible that Shell's new chief executive Ben van Beurden is getting all the bad news as early as he can. If this was the case, we should expect much better results going forward. Let's take a look at Shell and decide whether it makes sense (or not) to go long on the company's shares.

New projects coming on line.

Despite the recently disappointing earnings figures, Shell did learn from its 1990's experience (when the company heavily under invested) and is now investing for the future. The company has $149 billion of capital tied up into new projects which, at $100 Brent crude price, should generate an operating cash flow of $200 billion as the projects fully ramp up by 2015. Indeed, Shell has started up several new oil and gas projects in 2013, including deep water Brazil, integrated gas in Australia and Iraq. Moreover, the company keeps on investing on Liquified Natural Gas (LNG) projects, where its currently the world leader in a tight LNG market.

A high and secure cash dividend.

Unlike most of its major oil peers, Shell's dividend has not been cut since the 1940s. Even if a great track record does not guarantee future performance, Shell's stated policy is to grow its dividend over time in line with underlying cash flows. This means that once Shell increases the dividend, it does not want to pull it back. According to most analysts, Shell should be growing its cash dividend at a 3% to 4% year-over-year (yoy) rate. The company now trades at a 2014 5.5% cash dividend yield. Well ahead of Chevron's (CVX) and ExxonMobil's (XOM) 3.4% and 3% cash yields, respectively.

On Valuation.

Shell trades at 2014 8.9 times earnings and 5.1 times EV/EBITDAX, which is a significant discount to most of its big oil peers. For example American majors such as Chevron and ExxonMobil sell for 2014 6 and 8.7 times EV/EBITDAX, respectively. Other majors such as the troubled British Petroleum (BP) or Italian oil leader Eni (E) sell for 2014 5.5 and 5.4 times EV/EBITDAX, respectively.

Bottom line.

For years now, Shell's new CEO has been saying that the company should be skeptical of "elephant projects". Hence, I believe winds of change have arrived and Shell might be now cleaning up its books in order to refocus its growth strategy to smaller but less risky investments. The huge Capex tab will still be there on the company's books but Shell might now diversify its investments into a higher number of projects. I believe 2014 shall be a transitional year for Shell but it might also be the start of a new era more focused into growing the company's Returns On Invested Capital (ROIC), which are significantly lower at Shell than at its closest competitors – Shell's third quarter 2013 ROIC were more than 3% below those for ExxonMobil and Chevron. If this sharp fall in earnings represents just a book clean up, we should all feel positive about Shell's future. Time will say but investors such as Tweedy Browne (Trades, Portfolio) seem to be already betting on the “clean up” theory.