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On Nov 26, Zacks Investment Research downgraded Europe’s largest oil company, Royal Dutch Shell plc (RDS.A - Analyst Report), to a Zacks Rank #4 (Sell).

Why the Downgrade?

On Oct 31, Shell reported third quarter 2013 adjusted earnings of $1.43 per ADR, well below the Zacks Consensus Estimate of $1.70. This was the company's second consecutive miss.

Results suffered due to higher costs, lower output, supply disruptions in Nigeria and a drop in refining margin. Segmental performance was also weak with both the Upstream and Downstream segment earnings falling below the prior-year level.  

The fourth quarter does not seem bright for the company either. Shell expects a year-over-year drop of 60 thousand barrels of oil equivalent per day in production amid heavy maintenance activities. Moreover, operational regularity in Nigeria remains uncertain.

Shell promises to increase cash flow through several new ventures that are underway but these are unlikely to contribute to the company’s cash balance in the near term.

Moreover, Shell’s relatively heavy downstream exposure leaves it less diversified than its integrated peers. As such, the group’s results remain greatly exposed to refining/marketing margins, which were one of the reasons for the weakness in the third quarter.

Based on several such factors, the Zacks Consensus Estimate for the fourth quarter has moved down 6 cents to $1.94 over the last 30 days. The Zacks Consensus Estimate for the full year also moved down 53 cents (or 6.8%) in the same time frame and is currently pegged at $7.28.

Stocks That Warrant a Look

We expect Shell to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock. Meanwhile, one can consider other stocks in the energy sector like the Zacks Ranked #1 (Strong Buy) SM Energy Company (SM - Analyst Report), Helmerich & Payne, Inc. (HP - Analyst Report) and Harvest Natural Resources Inc. (HNR - Snapshot Report) which have solid growth potential.

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