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Royal Dutch Shell plc and Gemfields plc: the perfect resources partnership?

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By Peter Stephens – Wednesday, 29 June, 2016

With the price of oil having made a storming comeback since earlier this year, Shell (LSE: RDSB) now has a much brighter future than it did just a few months ago. Clearly, there are still challenges ahead for the oil major, with there being a very real possibility that the price of oil could come under further pressure. That’s especially the case if Brexit acts as a negative catalyst on global economic growth and demand for oil falls yet further.

However, even in such a situation, Shell remains an appealing play due to its size and scale. In fact, Shell would be likely to benefit from such a situation, since it could likely outlast most of its sector peers and emerge in a stronger position with greater market share when oil eventually recovers.

Furthermore, Shell’s share price growth over the coming years is likely to be much more closely aligned to its progress in integrating the recently-acquired assets of BG. Shell now believes that the synergies from the deal will exceed its initial expectations and this bodes well for the company’s profitability and for its free cash flow.

In fact, Shell plans to deliver free cash flow of between $20bn and $25bn per annum within four years. This compares favourably to the average free cash flow of $12bn per annum over the last three years and should provide the company’s investors with a rapid boost to their incomes. And with Shell yielding 6.7% at the present time, its future as an income stock remains very bright. This could push its shares higher even if interest rates now begin to rise following Brexit.

Rapid earnings growth

Of course, Shell’s size and scale means that its earnings growth rate may not be as high as that of a smaller resources peer. As such, combining it within a portfolio with a stock like Gemfields (LSE: GEM) could be a shrewd move.

Although Gemfields is a fraction of the size of Shell, is far less financially sound and pays no dividend, it’s expected to record a rapid rise in its bottom line next year. In fact, the Africa-focused coloured gemstone specialist is forecast to deliver an increase in earnings of 328% in the next financial year. This rate of growth doesn’t yet appear to have been priced-in by the market, since Gemfields trades on a price-to-earnings growth (PEG) ratio of just 0.1 following its share price fall of 12% since the turn of the year.

Clearly, there’s scope for a downgrade to Gemfields’ outlook and commodity prices will continue to fluctuate. However, with such a wide margin of safety its shares could perform exceptionally well, even if its outlook deteriorates. By pairing it up with a resources major such as Shell, an investor may be providing himself/herself with a degree of protection in case of a challenging period for commodities. Therefore, both Shell and Gemfields could be worth buying for long-term investors.

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Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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