BARRON'S TAKE
Shell Should Do Well
By TIERNAN RAY
Royal Dutch Shell's just announced reorganization should reward shareholders.
WHEN BIG COMPANIES play musical chairs, all too often little to nothing comes of it.
But in the case of Royal Dutch Shell (ticker: RDSA), which sports a hefty $162 billion market capitalization, costs clearly haven't kept pace with a tough economic environment. This offers hope that today's decisive reorganization will tangibly boost results.
With an operating cash-flow yield of around 23% and a juicy 6.5% dividend yield, Royal Dutch is still one of the best majors to own, as Barrons.com wrote earlier this month. (See Weekday Trader, "An Oil Giant Shakes Off Its Slumber," May 13, 2009.)
And today's shake-up will put greater scrutiny on the areas where the company has fallen short, especially its performance in North America.
Royal Dutch's CFO, Peter Voser, who becomes CEO on July 1, said the company will merge its liquefied natural-gas unit with its upstream business, the part that digs for oil.
Combining gas with exploration is something many other majors have done, and can bring substantial cost savings, explains ING analyst Jason Kenney in a note today.
"[France's] Total SA (TOT) and ExxonMobil (XOM) seem to benefit in a differentiated way from peers by having LNG included in their upstream divisions," writes Kenney, "which makes sense given the value chain synergies that can perhaps be better realised under such a strategy (targeting upstream resources into mid and downstream demand)." BP (BP) last year integrated its gas operations as well, he notes.
Royal Dutch's upstream business, furthermore, will be split into a North American and an international business.
The bad news is that many investors will take today's shifting of the deck chairs as a sign that poor performance in the U.S. and in liquefied natural gas will persist for some time into the future.
When the company announced first-quarter results on April 29, it missed estimates badly, hurt by liquefied natural-gas earnings that were sharply below some analysts' estimates. U.S. oil and gas production was also light of estimates.
Such a situation is frankly inexcusable, considering that Shell has some of the best pricing power in natural gas among its peers.
As Barclays Capital analyst Tim Whittaker in London writes in a note today, Shell's cost of doing business is just too high even for energy markets that are heating up. "Shell currently has the highest cash break-even of all the integrated oil companies in our coverage, at $137 per barrel."
With oil supply generally loose around the world and OPEC indicating it will keep enough product on the market to maintain rational oil prices, Shell simply can't count on a $137 per barrel price again anytime soon.
So, in a market where oil is rising past $60 per barrel and the company has the pole position in gas prices, upside just hasn't kept up.
The good news is that with North America and International now taking more blame, er, responsibility, for the bottom line, the company appears to be in a position to demand greater efficiency on cost.
As Whittaker puts it, "If upstream unit costs improved by $1 per barrel, this would lift our 2010 and 2011 EPS forecast by 4% to 5%."
With Shell's stock at $53 and 38% below its 52-week high, the stock looks like a compelling buy.
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