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Is Royal Dutch Shell A Buy At 52-Week Lows?

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Extracts from an article by Mihir Mehta: 11 Jan 2016

Summary

Shell has had a bad start to 2016 and is trading close to its 52-week low, but investors should not consider this as an opportunity despite a strong balance sheet.

Shell’s strong balance sheet is overshadowed by the fact that its gross margin has declined and leverage has increased as compared to big oil players such as Exxon and Chevron.

Shell’s leverage growth of 32% is almost four times higher than BP’s leverage growth, indicating that its interest burden has increased at a faster pace than rivals.

Shell’s fundamentals have worsened due to weakness in the upstream segment, a trend that will continue as oil demand will slow down this year due to weakness in China.

The global oil supply glut will worsen this year as Iran ramps up production to take advantage of the lifting of sanctions on its exports, creating another headwind doe Shell.

Potentially weaker oil pricing is a big threat

As already seen above, crude oil prices have turned out to be a headwind for Shell and have negatively impacted its financial performance due to weakness in the upstream segment. Looking ahead, this weakness in the upstream segment will continue and impact Shell’s performance in a negative manner given its substantial size are compared to upstream.

I’m saying this because 2016 has started on a very bad note for the oil industry, with the Brent declining to levels last seen in 2004 at around $33/barrel. Crude oil has been pushed to these levels due to a number of reasons, including an economic slowdown in China, and this trend is not going to fade away anytime soon. For instance, after growing 6.9% last year, it is anticipated that China’s economic growth will slow down to 6.8% this year according to the People’s Bank of China.

However, banks such as Nomura believe that China is being too optimistic about its growth and the country’s growth could be as low as 5.8% this year. Now, as China is among the biggest importers of crude oil in the world, a slowdown in economic growth will affect oil demand negatively. This is because manufacturing activity and industrial production will come down in the country, so it will need less oil. As a result, it is expected that China’s oil demand will grow by 300,000 barrels per day this year, down 41% from last year.

This will have a negative impact on global demand growth, which is expected to slow down to a range of 1.20-1.25 million barrels per day this year from around 1.8 million barrels per day in 2015. But, at the same time, it seems like supply in the global crude oil market is not going to come down anytime soon as Iran is ready to flood the market with more oil as sanctions on export are lifted this month. In fact, Iran has already taken stock of its oilfields and is ready to increase production.

According to News.az:

“Iran is expected to add 500,000 b/d to its oil exports after the sanctions are lifted. It will continue to raise exports to 1 mb/d six months after.

Iran exported 2.3 mb/d-2.5 mb/d of oil before US and European sanctions targeting its energy sector cut the sales by half in 2012. Saudi Arabia, Russia and Iraq ramped up production to replace the Iranian oil.”

This means that there is a lot of room for Iran to ramp up production and flood the global market with more oil, especially because it used to be the second-largest producer in the OPEC, which accounts for 40% of global oil production. Hence, as a result of increased oversupply and slowing demand, oil prices will worsen going forward and this is bad news for Shell.

Conclusion

Considering the points presented above, the odds are stacked against Royal Dutch Shell. Due to further weakness in oil prices, the company’s fundamentals will take a hit and its balance sheet will weaken. So, in my opinion, even though Shell trades at its 52-week lows, investors should continue staying away from the stock.

FULL ARTICLE

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