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The 10pc fall in Royal Dutch Shell is unwarranted

Europe’s largest oil major by market value has seen its shares slide by almost 10pc since the start of May, as concerns about global growth mounted.

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Questor share tip: The 10pc fall in Royal Dutch Shell is unwarranted

Royal Dutch Shell falls are overdone. Questor says buy

By 6:00AM BST 04 Jul 2013

Royal Dutch Shell ‘B’
Questor says BUY

A significant oil discovery in the Gulf of Mexico failed to boost shares in Royal Dutch Shell yesterday. Europe’s largest oil major by market value has seen its shares slide by almost 10pc since the start of May, as concerns about global growth mounted. So, now looks like a good time to buy one of the UK’s largest income payers.

Yesterday, Shell said that an exploratory well at Vicksburg in the deep waters of the Gulf of Mexico revealed potentially recoverable resources of more than 100m barrels of oil equivalent (boe). The find adds to more than 500m boe of potentially recoverable resources that have already been identified at a nearby discovery called Appomattox.

This is good news for Shell, as replacing its oil reserves was an issue for the group last year. Over 2012 the group had a reserve replacement ratio of just 44pc. This figure measures the amount of proved oil reserves Shell added to its books relative to the amount of oil and gas it extracted. Obviously, to grow the group needs to find more oil than it extracts each year.

So, why have Shell shares been falling? Consensus earnings forecasts for this year have moved slightly lower over the past few months. There have been concerns about a slowdown in the Chinese economy and the oil price has fallen, prompting analysts to bring out their red pens.

Brent crude prices are down from their high of $108 a barrel in February to just under $105 today. Also, analysts have forecast that earnings per share will be slightly lower this year than they were in 2012 before returning to growth in 2014.

This could go some way to explaining the share price fall, however, it does not get to the root of why Shell is trading at an earnings discount to other oil majors.

Shell’s current-year earnings multiple is 7.8, falling to 7.7 next year. This compares with US group ExxonMobil, which trades on a 2013 multiple of 11.4, falling to 11.3 despite its significantly lower yield. BP trades on a multiple of 8.2, falling to 7.3, despite the uncertainty regarding total liabilities from its huge spill in the Gulf of Mexico.

Some of this subdued valuation may be down to the fact that Shell is highly exposed to shale gas plays in the US, where a glut of gas has kept natural gas prices low. The company has allocated $6bn (£3.9bn) of funds to shale gas globally and in the US its portfolio includes about 3.5m acres of mineral rights with the potential to yield 40 trillion cubic feet of natural gas. This is the energy equivalent of nearly 7bn barrels of oil. Indeed, this exposure prompted Simon Henry, Shell’s chief financial officer, to say in May that this was one reason the company would not be investing in UK shale as “nobody even knows whether the gas will flow”.

However, Questor is relatively unconcerned about these issues. Shell plans to boost output from 3.3m boe per day in 2012 to 4m boe in 2017. This is an increase of more than a fifth. The company has the cash to invest and increase its dividend. Last year, its net cashflow from operating activities was a whopping $46bn. This is despite the fact that Shell has divested a large amount of assets over the past three years, raising $21bn in the process.

The group’s tie-up with Gazprom to explore the Arctic is also a sound move. In April the two companies signed a memorandum to partner in the Russian shelf development for shale oil.

Shell is also expected to increase its dividend 6pc this year in dollar terms. With the US currency significantly stronger against sterling this year, there should be a currency benefit, too. The prospective yield this year is a healthy 5.4pc, rising to 5.6pc.

Questor thinks investors should use the recent falls in the price of Shell shares to buy.

Note: UK investors should buy the “B” shares, not the “A” class shares, to prevent potential problems with double taxation.

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