The Rising Influence of Rising Affluence

[DewDiligence]

Shell’s pre-announced earnings miss was ugly, but the share price dropped on Friday only 1.6% and 1.8%, respectively, for RDS-A and RDS-B. Moral: When a stock trades at a dirt-cheap valuation, a lot of bad news is already baked into the share price.

Some excerpts from Forbes:

http://www.forbes.com/sites/christopherhelman/2014/01/17/what-the-hell-shell-oil-giant-warns-on-disastrous-quarter/

Royal Dutch Shell released a dreadful profit warning today. Fourth quarter earnings are expected to come in at $2.2 billion, down from $7.3 billion a year ago. [These figures are on a CCS basis including the non-recurring $700M writeoff regarding the Eagle Ford.] Full year earnings will be down almost 40% to $16.8 billion. Upstream earnings were off 45% year-over-year, while downstream refining earnings plunged 58%. Topping it off, in the past year Shell’s oil and gas volumes have slumped roughly 13% to 2.9 million barrels of oil (and natural gas equivalents) per day.

How could this happen at a time when oil prices have been hovering around $100 and demand for liquefied natural gas remains strong? Shell cited high maintenance expense, especially at its gas-to-liquids plant in Qatar. Deteriorating security in Nigeria also was a hit. Refining margins continued to be poor in Asia and Europe.

But perhaps the biggest single hit to earnings in the quarter was the $700 million asset impairment charge believed to be tied to Shell’s lackluster exploration venture in the Eagle Ford shale of Texas. [I don’t understand the author’s use of waffle words here—the $700M writeoff is known to be related to overpaying for acreage in the Eagle Ford.]

…When it comes to capital spending, a little improvement will go a long way. In 2013 Shell generated $40.4 billion in cash flow, but used it all up, and then some, with a remarkable $44.3 billion worth of capital spending on new projects such as deepwater developments in the Gulf of Mexico and LNG in Australia. Will all that new investment help Shell find new profitability in the years to come? Investors sure hope so.

But a few more quarters like this one and the pressure will mount on CEO van Beurden to start slashing that capex and put Shell into a managed shrink-down like CEO Robert Dudley has been forced to do at BP.

Shell’s performance on almost any financial metric has been mediocre for years, but that’s the main reason the valuation is so low. I’m willing to bet that the very large capital spending in recent years (largely on LNG projects) will eventually bear fruit, and I’m getting paid a 5% dividend yield while I wait.