On Dec 31, Zacks Investment Research downgraded the integrated energy giant, Royal Dutch Shell plc (RDS.A), to a Zacks Rank #5 (Strong Sell).
Why the Downgrade?
Shell is an integrated energy firm but has a large upstream exposure, the segment comprising about 77% of its income. This makes the company more susceptible to commodity price changes than its more diversified peers.
With a tumble in crude oil price – which fell over 50% since Jun 2014 – revenues, cash flows and earnings are likely to be negatively impacted. Also, NYSE-listed ADRs of Shell have declined over 19% in the same period. The recent fall in natural gas price further adds to the woes.
In this weakly priced market, Shell may find it difficult to maintain its lofty capital spending and dividend payments. The company projects investment of more than $40 billion for full year 2014 which is quite high by industry standards. This is expected to substantially increase the group’s leverage and deteriorate its credit metrics. In 2013, the company’s operating cash flow did not cover capital spending and dividend, and this trend is likely to continue in 2015 as well.
Moreover, the company is strategically selling its non-core assets. Though this is likely to be favorable in the long term, lost reserves and production would hamper earnings in the near term.
In keeping with these views, several brokerage firms have lowered earnings estimates for both the current quarter and the current year, indicating more bearishness ahead.
Other Stock Picks
Despite the current weakness in the energy sector, one could consider better-ranked players like Seadrill Partners LLC (SDLP), Spectra Energy Partners, LP (SEP) and QEP Midstream Partners, LP (QEPM). All these stocks sport a Zacks Rank #1 (Strong Buy).
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