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Overview of Royal Dutch Shell

Royal Dutch Shell (RDSb London Stock Exchange, RDS.B NYSE) is in my opinion a fantastic stock that is undervalued. It’s been profitable even in years in which oil prices were plummeting.

In an environment where traditionally safe investments are risk free reward Shell stock provides an attractive 5.86% yield. While I don’t provide personalized investment that is suitable for an individual’s unique situation I have determined that owning stock in Royal Dutch Shell makes a lot of sense for me.

When I value a stock there are a number of metrics I look at when evaluating a security:

1) Enterprise Value to Market Capitalization (EV/Market Cap)
2) Enterprise Value to Free Cash Flow (EV/FCF)
3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
4) Enterprise Value to Owners’ Cash Profits (OCP)
5) Operating Margin
6) Dividend Yield
7) Return on Equity (ROE)

Energy production is very capital intensive so I’ve compared Royal Dutch Shell (RDSb) to similar companies: Exxon Mobil (XOM), Total (TOT), and Chevron (CVX).

Data is from as of 13 March 2018 (with the exception of EV/Owner’s Cash Profits) which is from as of 16 March 2018.

So how does RDS compare to other oil companies of a similar size?

1) EV/Market Cap

I like to see an EV/Market Cap below 1. Of these four energy companies none meets this criteria and RDSb is actually the highest. Total is the lowest just edging out Exxon Mobil by what amounts to a rounding error.

RDSb – 1.242
XOM – 1.134
TOT – 1.129
CVX – 1.154

Winner: Total (TOT)

2) Enterprise Value to Free Cash Flow (EV/FCF)

EV/FCF is where RDSb really shines compared to it’s peers. EV/FCF is in my view a more accurate measure than Price to Earnings (PE). The lower the Enterprise Value compared to Free Cash Flow means you’re paying less for an earnings stream.

RDSb – 19.55
XOM – 24.42
TOT – 28.99
CVX – 36.15

Winner: Royal Dutch Shell (RDSb)

3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)

Another metric which I think is superior to Price to Earnings where a lower is better.

RDSb – 18.31
XOM – 18.57
TOT – 14.68
CVX – 26.98

Winner: Total (TOT)

4) Enterprise Value to Owners’ Cash Profits (OCP)

16 March 2018 Update:

EV to Owners’ Cash Profits is yet another metric that I believe is more accurate than price to earnings.

EV / Owner’s Cash Profits / EV/Owner’s Cash Profits
RDSb – 331.89 / 8.875 / 37.4
XOM – 357.85 / 9.753 / 36.69
TOT – 170.82 / 5.36 / 31.88
CVX – 254.97 / 0.758 / 336.41

Winner: Total (TOT)

Source: yCharts

5) Operating Margin %

All else equal a higher operating margin percent is better than a lower one. Exxon Mobil wins by a large margin in this category.

RDSb – 6.59%
XOM – 19.71%
TOT – 4.91%
CVX – 6.72%

Winner: Exxon Mobil (XOM)

6) Dividend Yield

Stocks in the oil and gas industry typically pay good dividends. Shell pays the highest of these four:

RDSb – 5.86%
XOM – 4.09%
TOT – 4.84%
CVX – 3.73%

Winner: Royal Dutch Shell (RDSb)

7) Return on Equity (ROE)

The ROE of Shell lags it’s peers. I typically look for an ROE over 8%.

(TTM) / (5 Year)
RDSb – 5.61% / 6.48%
XOM – 11.10% / 13.54%
TOT – 7.85% / 8.19%
CVX – 6.26% / 8.31%

Winner: Exxon Mobil (XOM)

Reasons to be Cautious

Shell has a payout ratio of 144.6% which means that the dividend might be unsustainable.

However, Royal Dutch Shell’s payout ratio has been below 100% from 2008 up through 2014 and I think that the payout ratio will drop to a sustainable level in the next year or two.

The return on equity for shell has also been lower than I’d like but they are also in stronger financial shape (based on the current ratio and quick ratio) than ROE king Exxon.

Another Valuation Metric for Royal Dutch Shell

One way to calculate a margin of safety is by determining what multiple of the EBIT the stock is trading at. I could write an entire article on how this is calculated (shout out to Jason Rivera who I learned this technique from).

Basically I’m looking at (EBIT * 14) + Cash Equivalent / Shares

Using the number 14 in the equation might seem somewhat arbitrary but it isn’t. The reason I chose that is because if you plug in 13.5 you get the current share price of Shell. In other words Shell is trading at EBIT x 13.5 + Cash Equivalents.

Using this metric (using a multiple of 14) we find a “fair” share price of each of these four stocks would be as follows:

RDSb – $65.9
XOM – $64.1
TOT – $75.8
CVX – $72.7

And if we compare the actual share price to these values we get the following “margin of safety” for each stock:

(EBIT * 14 + Cash) / (Current Share Price) / (Margin of Safety)
RDSb – $65.9 / $63.59 / -3.49%
XOM – $64.1 / $74.53 / 16.27%
TOT – $75.8 / $57.66 / -23.91%
CVX – $72.7 / $116.46 / 60.12%

Winner: Total (TOT)

Using this technique we can see that Royal Dutch Shell is trading at about a 3.5% discount to 14xEBIT + Cash. Exxon is trading at a 16.27% premium, Total is trading at a generous 23.91% discount and Chevron is overvalued by a large 60.12%.

Royal Dutch Shell Class A or Class B Shares?

I used to own RDSa in a Roth IRA. The RDSa shares are subject to a 15% withholding to the Dutch government. Because of this RDSa trades at a discount to RDSb, which does not have this withholding.

At one point you could get around the 15% withholding through Shell’s scrip program (which they have discontinued twice) and get a lower price and higher yield. So it made sense to own RDSa.

But given that the scrip program has been discontinued I choose to own RDSb. I prefer to own it on the London Stock Exchange and I also own it in US markets in a Roth IRA.

Royal Dutch Shell is an Excellent Value

Shell is a great value, a cash flow machine, and pays with a strong dividend. Total is an excellent value as well although it has thin operating margins and has struggled to generate free cash flow with the same consistency as Shell and so for those reasons I prefer Royal Dutch Shell.