The climate change movement is the greatest long-term threat to the oil & gas industry. Hence, companies responsible for fossil fuel exploration, production and marketing have confronted the trend. However, not all strategies have been the same or meet with the same results. For example, Exxon Mobil (XOM) fiercely countered the movement, while competitors explored other options. Royal Dutch Shell (RDS.A) has taken the alternative road and adopted many projects that highlight the company's compromise with the environment. Specifically, management announced the signature of an agreement with the UK government to move forward with the Peterhead Carbon Capture and Storage project. The approach seems to have paid increasing dividends in the public's eyes, while some doubts have been casted over the strategy's long-term viability. So, is Royal Dutch Shell expected to grow or stumble?
- Richard Pzena Stock Picks
- Richard Pzena Current Portfolio
- This Powerful Chart Made Peter Lynch 29% A Year For 13 Years
Business Strategy and Overall Performance
In the latest report, Royal Dutch Shell confirmed a business strategy focused on the long-term. That is why the approach to the climate change environmental movement should be interpreted as part of that strategy. The agreement with the UK government aims to capture 10 million tons of carbon-dioxide over 10 years. For the same reason, a review of the last annual report is worthy of analysis to asses future performance.
In addition to a long-term business strategy with an environmental concern, Royal Dutch Shell focused technology and innovation. In this sense, the most important project underway is the floating liquid natural gas facility. The asset is under construction in South Korea's shipyard and will be used to tap resources off Australia's coast. Now, many reserves considered out of reach because of cost or depth will turn profitable.
With regards to human resources, Royal Dutch Shell has made an important investment by hiring around 1,200 graduates throughout 2013. Additionally, the company opened a training center at Sarawak, Malaysia, to equip employees with technical and operational skills to build and manage difficult projects. The center is unique in the region and available to local and foreign employees focused on deep water resources.
The three-legged strategy put forth by Royal Dutch Shell serves long-term objectives, but also represents the company's approach to a challenging economic environment. The world economy has recovered from the 2007/8 crisis, but performance across regions is not equal. For the company, the most challenging region continues to be Europe, and growth remained similar to 2012 levels.
What the Report Ignores
Challenges and difficulties for Royal Dutch Shell go beyond an economy in slow recovery with struggling geographies. At the same time, higher exploration costs have been identified to be compounded by lower oil and gas output. The context is further aggravated by a troubled refining unit performing weakly. These difficulties have shown to be considerable during the fourth quarter of 2013 particularly.
Compared with other integrated players, Royal Dutch Shell is considerably exposed to downstream and gas activities. Additionally, the company is heavily investing on projects with unproven impact, reducing market leverage and credit metrics. One last risk derived from geographical diversity is political instability. However, the company is at a comparable advantage with respect to other integrated players. Most importantly, gas prices are not expected to climb in the near future due to an over supplied market.
Financially, Royal Dutch Shell is strong amid declining revenues and net income during the last three years. Additionally, debt and cash flow are two metrics that deteriorated in the last year. And stock is trading at 13.7 times its trailing earnings, carrying a 30% premium to the industry average. It is interesting to see how gurus are divided among prospects: two gurus increase their holdings, two reduced it, one sold out and another made a new purchase. More relevant it is the trust place by three largest shareholders - Richard Pzena (Trades, Portfolio), Renaissance Technologies, and Steven Cohen (Trades, Portfolio)- increased their holdings throughout 2013. Since the stock is going through the low cycle, taking a position in the company for a long-term is recommendable given the business strategy adopted and opportunities for growth in the gas industry.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.
This article first appeared on GuruFocus.