Stephanie Link: Can New CEO Change Royal Dutch Shell's Course?
By: Stephanie Link | 02/24/14 - 08:58 AM EST
NEW YORK (TheStreet
) -- I always like a good restructuring story especially where a company has good assets, a strong balance sheet and solid Free Cash Flow generation potential. Royal Dutch Shell
(RDS-A) fits the bill in my view. It is one of the largest energy producers in the world that operates in 140 countries, has a total proved reserve base of over 13 BBOE (Billion Barrels of Oil Equivalent) and average production in excess of 3.4 mmboe/d (millions of barrels of oil equivalent per day).
It has exposure to just about every part of the oil/gas food chain including upstream, downstream, transportation and petrochemical segments.
Over the last several years the company has mismanaged its huge shale asset base, has had multiple cost overruns on key projects and continues to run an underperforming refinery business. Last year alone, Royal Dutch Shell's operational issues in Nigeria, Iraq, Kazakhstan, Alaska, and the U.S. cost its earnings by $5.1 billion. So it's not surprising that the stock massively underperformed its peers last year, gaining just 3.4% vs. the sector, which rose 14.1%. There is no doubt this company and the management team have a credibility problem. But that is about to change, in my view with a new CEO on board, Ben van Beurden.
Yes, he's been at the company for 30 years and is an "insider" and ideally investors wanted an outsider for a "fresher" perspective. But van Beurden is well respected and has come out of the gates with a bang. He started the first of the year and signaled that there will be change ahead with a focus on profitability, capital efficiency, returns and cash flow. The company has a number of non-core and underperforming assets that it could sell and generate $15 billion in Free Cash Flow over the next few years - which in turn will be used for buybacks and dividend increases. It already sports an attractive 4.9% dividend yield, but there is upside here and this is the preferred choice by management to increase.
There is an analyst meeting on March 13 which will provide more details on its game plan - but I am not expecting big financial targets at this meeting. It's too early for the new CEO to issue them. But any details of how he plans on improving existing returns and identifying non-core assets will give a clue on the opportunities for the company going forward. That said - we do know that $80 billion of its capital employed or 40% of its total $226 billion comes from the Oil Products segment and the North American unconventional positions - where the returns have been meager.
The North American assets lost $2 billion last year and the Oil Products segment posted a meager 4% ROACE (Return on Average Capital Employed). This is not acceptable, according to the CEO, and the two areas will see big changes. Any news on these two segments will drive the stock performance in my view. In addition the company already sold many of its flailing Downstream operations. It announced the sales of its retail, supply, distribution and aviation business to Kuwait Petroleum and will concentrate its non-services segments (especially in its heavily invested areas in Italy). It has also made refinery sales in the UK, Germany, France, Norway, and the Czech Republic and has sold some of its downstream assets in Egypt, Spain, Greece, and Sweden. These are all part of a concerted effort to downsize this segment so that it can compete more effectively in those selected areas where it sees higher returns.
After it sells down these non-core assets it's left with a pretty attractive project base positioned for growth. In 2013, the company started up seven major projects that have the potential of 180 mboe/d when they get to full production. It has another four that will begin this year - three are deep-water fields where Royal Dutch Shell is the lead operator and one that came from the Repsol LNG acquisition which is being integrated into the Shell platform. It will spend $6 billion this year on its LNG facilities, mainly in Australia - the Gorgon and Prelude and other projects in the U.S. and Canada.
Cash at the end of the year was $9.7 billion and its net debt ratio stands at just 16%. It isn't likely to move this up by much - Royal Dutch Shell has indicated that 20% is its comfort level as it goes through the restructuring process. But again, as the company continues to sell non-core assets, it should generate ample cash to meaningfully increase the buybacks and dividends in the future. At 10.9x forward estimates with its strong dividend yield and a new CEO with ambitious goals to improve profitability and returns, I like the risk/reward. My target is mid $80s over the next 12 months.
--Written by Stephanie Link in New York.