The Rising Influence of Rising Affluence

[DewDiligence]

This WSJ piece says Shell > XOM, but I’m not convinced.
(Both companies reported 2Q11 earnings today.) Comments?

http://online.wsj.com/article/SB10001424053111904888304576474350629961610.html

›Exxon's Turn to Shell Out

JULY 29, 2011
By LIAM DENNING And ANDREW PEAPLE

Exxon Mobil and Royal Dutch Shell really should pick different days to report their quarterly numbers. Investors could have been forgiven for wondering which was which on Thursday. Shell can live with that. For Exxon, it's a problem.

Over the past decade, Exxon's stock has traded at an average premium of 28% to Shell's on a forward price/earnings multiple. Two years ago, it stood at 60%. Today, however, the gap is a mere 9%. The reason is that what once weighed on Shell's valuation now burdens Exxon's. [Maybe the reason is that investors aren’t sure they like XOM’s newfangled interest in shale plays.]

Shell spent much of the past decade making up for the reserves scandal of 2004. Big capital expenditures were then required to rebuild the asset base. From 2005 to 2010, Shell reinvested 80% of its operating cash flow, according to data from Capital IQ, against an average for Exxon, BP and Chevron of 54%. Exxon's own figure was 40%. As the rest of the big oil companies passed on huge free cash flows to investors amid the oil boom, Shell had to toil away in the fields for its sins.

On Thursday, though, it was Exxon that raised concerns on spending. Exxon hasn't suffered a debacle like Shell. But as Shell did earlier, Exxon is now investing more to build new reserves, with a particular focus on unconventional natural gas [#msg-52105887]. Exxon spent $10.3 billion in the quarter, ahead of expectations, and left the door open to more "opportunistic" spending. In contrast, Shell spent $8 billion across the entire first half of the year.

Not only has Shell reined in spending, its cash-flow potential is now emerging in a striking way. "Although Exxon's quarter was impacted by some downtime, Shell's cash flow is now catching up to Exxon's in absolute terms," says Edward Westlake, head of oil research at Credit Suisse.

Shell generated $25 billion of operating cash flow, before working capital movements, in the first half, not far off Exxon's $29 billion. [Yes, less cap-ex means more cash flow—duh!] What's more, Mr. Westlake points out, some major Shell projects, built during that earlier spending spree, have barely started producing. Shell expects its QatarGas 4 and Pearl gas-to-liquids operations in the Middle East to generate $4.5 billion of annual cash flow when fully up and running at a $70-a-barrel oil-price assumption [#msg-61293785].

More than accounting earnings, cash flow provides the building blocks of valuation. Despite the catch-up going on, though, Shell's market cap of $239 billion is only 57% that of Exxon's. [The proper valuation comparison is between the two companies’ enterprise values, not their market caps.] Having put in the hard work, the Anglo-Dutch oil company deserves more recognition than that.‹