Attractive Price Levels, High Return Expectations Make Royal Dutch Shell A Must-Buy

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Feb 27, 2015
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Last year, almost all the oil and energy companies suffered a big blow when oil prices came crashing down. In less than a year, oil prices came down by almost 50%, affecting the businesses of many energy giants. However, there were a few companies that managed to hold on well through these tumultuous times due to effective financial management. Royal Dutch Shell (RDS.B, Financial) was one of them. Let us now analyse why buying shares of Shell would be the right move now.

Downstream business to the rescue

Upstream and downstream are the two main areas of business for any energy company. Upstream involves exploration and drilling whereas downstream deals with refining. The main reason why Shell was able to wade through the rough waters successfully was that its downstream business improved greatly. Usually when oil prices slump, it is the upstream business that gets affected a lot as low prices can hit exploration severely. Shell also was affected by this. Its net profits for 2014 were close to $15 billion, a drop by 8% from the values of 2013. Nevertheless, its downstream business came to its rescue during this crisis situation.

Downstream business contributed to 27% of Shell’s total business; earnings from this segment for 2014 were $6.2 billion, a whopping 40% from the earnings during the previous year. The increase in revenues in this segment, covered up for the losses suffered by Shell in its upstream sector. Though it cannot be denied that Shell suffered a loss in net profits, one has to admit that it fared quite well when compared to some of the other energy companies.

Good returns to investors

At present, Shell’s dividend yield is an impressive 5%. If you are an investor in Shell, you need not panic due to the decrease in oil prices. Shell always considers shareholders’ interest as its first priority and there is hardly any other energy company that thinks on the same lines. The company is involved in making some strategic decisions in order to continue paying dividends to shareholders. It has been able to generate a reasonable amount of free cash flow every year through its effective planning and successful business model.

By bringing in some structure in its capital expenditure, Shell was able to generate free cash flow worth $25 billion for 2014, in spite of the rough climate in the oil and energy sector. Out of these, Shell returned $15 billion to its investors in the form of dividends and share repurchases. When most of the energy companies are struggling to stay in the business, here is a company that pays out so much to its investors. Experts recommend that Shell is a must-buy stock now, because its shares are trading at low prices just like all other energy companies. It is available in the market at just 1.2 times its book value, which is quite an attractive price for such a worthy stock.

Capital restructuring

In order to continue paying out to its investors and to maintain a healthy financial record, the first area that Shell worked upon last year was on its capital expenditure. Assets that had no potential to grow were sold off and all efforts were taken to cut capital costs as much as possible. This ensured that the company generated handsome returns on its capital. For 2014, Shell earned $15 billion just by selling off its non-productive capital assets. The move was brilliant, because the sell-off was done at the right timing, just before the slump in oil prices. The top management of Shell also confirmed that for the next three years, its capital costs would be reduced by close to $15 billion. This should bring cheer for the investors, because higher return on capital would only increase the free cash flow generating capacity of the company.

The trend of share price movement of Royal Dutch Shell for the past few months is shown below. From this, it is evident that share prices are trading quite low recently.

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Conclusion

Royal Dutch Shell is cash-rich oil and it knows to work its way through during adverse scenarios. It has made the right decisions at the right times, adding lots of value to investors. You have to buy the share right away, because you may not find these prices in the future when oil prices start to increase. With a high dividend yield, low prices, astute financial management and huge growth potential in the future, Shell presents itself as a perfect opportunity to you, so that you can reap great rewards in the long run.