We have downgraded energy major Royal Dutch Shell PLC (RDS.A) ADRs to Neutral from Outperform purely on valuation grounds, as we see limited near-term price upside.
With the economic rebound strengthening and with oil prices rallying, we expect integrated oil companies such as Royal Dutch Shell to continue accelerating revenue and earnings growth over the next few quarters. The group’s recent results have also benefited from its operational/production efficiency and contributions from growth programs.
At its annual strategy update, the Anglo-Dutch supermajor outlined plans to boost its focus on the more lucrative and well performing ‘upstream’ exploration and production end of the business. The group expects annual worldwide production to increase 12% by 2014 (from 2010 levels), driven by a new wave of project start-ups.
Shell’s targeted output rise, to 3.7 MMBOE/d, represents one of the most ambitious growth programs in the sector, to be achieved primarily by new projects coming onstream in Qatar, Australia and North America. The Hague-based group is currently assessing more than 30 new projects that should guarantee upstream growth to at least 2020.
However, at current valuations, we have a difficult time justifying sufficient potential return to support an Outperform rating. We expect Royal Dutch Shell’s returns to remain below average, as the group makes significant investments in large growth projects. Additionally, the firm’s relatively heavy downstream exposure is likely to limit its ability to generate positive earnings surprises. Consequently, we see the stock performing in line with the broader market.
Royal Dutch Shell – Europe's largest oil company by market value and ahead of BP plc (BP) and Total SA (TOT) – owns one of the largest integrated oil and gas businesses in the world. The group has operations all over the world and is involved in various activities related to oil and natural gas, chemicals, power generation, renewable energy resources and other energy-related businesses.
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