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Ray Merola

Ray Merola

I recently retired from Shell Oil after serving over thirty years in the energy industry.  My career was concentrated in the downstream business; serving various…

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Royal Dutch Shell: Strong Valuation Metrics and Dividend

My investment style has long been to find undervalued companies with a sound balance sheet, dividend yield support, good cash generation, and reasonable forward growth prospects.  Royal Dutch Shell (RDS.A) shares meet all these requirements.  To boot, I suggest these shares have been oversold due to the ongoing EU debt problems, making them an even more attractive investment.

RDS reports 2012 3Q earnings on November 1.  Pending any unusual surprises, this stock could be a good investment for income-oriented investors who are willing to ride out the European debt crisis and it's stock price headwind on many corporations domiciled there. 

Shell shares show some compelling screening metrics:

•    Annualized Dividend Yield of 5%
•    Return-on-Equity greater than 15% (TTM)
•    Return-on-Investment of 12% (TTM)
•    Price-to-Cash Flow of 7 times
•    Price-to-Book Ratio of 1.2
•    Current Ratio of 1.2

Royal Dutch Shell (RDS.A) One Year Price and Volume
Royal Dutch Shell One Year Price and Volume        
Source: Bigcharts.com.

Royal Dutch Shell is one of the six global Super Major energy companies; the market cap is $116 billion.  The other Super Majors include ExxonMobil (XOM), Chevron (CVX), Total SA (TOT), ConocoPhillips (COP) and BP PLC (BP). 

Royal Dutch Shell was formed over one hundred years ago via the combination of Royal Dutch Petroleum and Shell Transport and Trading Company. The corporation has major offices in London and Houston, with its headquarters located in the Netherlands. Shell has been focused on unconventional energy plays, as well as staking a global lead in the LNG business. Management has stated their intent is to emphasize the Upstream business vs. the Downstream, as well as a strategic direction to reduce the number of countries in which the company operates.

Investors should note that while the company is based in Europe, only 13% of its revenues are generated there. I believe this results in a level of "guilt by association" with respect to current price action. The stock has drifted down about 5% since it's March high, currently trading about $68 a share. A relatively weak earnings report last quarter did not help the cause.  Nonetheless, production and revenues have held flat or trended up, while SG&A expenses are down due to a concerted effort to cut costs.

RDS.A shares sport a high yield and a safe payout ratio. The board has shown the propensity to hold or increase the fat dividend, albeit by relatively small percentages of late.

The price-to-book ratio of 1.2 times is noteworthy.  The net book value of the company is about $56 per share.  The "A" shares are trading at $68.50 as of the date of this article.  The Shell balance sheet shows the company holding nearly $15 billion in cash. The equity/asset ratio, a favorite value measurement of Benjamin Graham, is 49%. The father of value investing considered companies with an E/A of 50%, representing good value.

The debt-to-equity ratio stands at 21%.

Here's how Shell stacks up against the other Super Majors:

Shell in Comparison with other Oil Majors

*Production Reserve Replacement Rates are a key operational metric for energy companies.  Figures included are in percentages.  The first figure is for Oil and the second is for Gas.  Figures cited are a three-year average and reflect core properties; they do not include outside purchases and sales.

One may notice that the return figures for ExxonMobil and Chevron are better than Shell.  However, I believe that given the lower P/E multiple, better dividend yield, and superior Production Reserve Replacement Ratios, Shell offers an investor better current upside.    

Investment Thesis

Any investor should have a thesis for owning a given security.  This includes a reason for purchase, and a catalyst that he/she believes can move the share price. 

In the case of Royal Dutch Shell, I submit that the shares are undervalued based upon fundamental metrics.  This is a result of pessimism about the global economy, as well as additional “guilt by association” given the company is headquartered in Europe and trades primarily on the UK and Dutch bourses.  Nonetheless, while the company is indeed based in Europe, less than one-seventh of its revenues are generated there.


Shell's foray into unconventional energy plays and leadership role in the LNG business differentiates it from some of its major competitors.  This emphasis, along with others involving GTL (Gas-to-Liquids) businesses in the Marcellus and Qatar, as well as Canadian oil sands projects will ensure that Shell can replace reserves adequately for years.  The company's Production Reserve Replacement ratio is significantly better than their competitors.  Nevertheless, the investor should expect that in the short-term, the current weakness in natural gas prices will continue to pressure margins.


Royal Dutch Shell is a sound choice for an undervalued energy play. The oil giant has demonstrated three good years of growing revenues, operating income, and net income; these metrics have flattened in 2012. The current 5.0% yield is atop the circuit. The dividend was maintained or grown throughout the Great Recession.  A price-to-book of 1.2 times, price-to-cash flow of 7 times, and one of the best ROI ratios in the industry make this Super Major my choice for a rock-solid energy stock that has been unduly punished by EU debt fears.

While it is certainly possible that an implosion of the European Union economy could wreak additional havoc on the shares, they now appear to be undervalued enough to start a position. As I already own shares, I will continue to accumulate slowly on additional weakness, assuming some level of yield support. I recommend doing your own homework before committing funds; please check out the earnings conference call on November 1.  If you choose to invest, always scale into stock investments via stages.

By. Ray Merola

If you liked this article, please visit my SeekingAlpha.com homepage:
http://seekingalpha.com/author/ray-merola to view other articles highlighting security analysis and investment ideas.

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