Still Neutral on Shell

We are maintaining our long-term Neutral recommendation on Royal Dutch Shell plc (RDS.A - Analyst Report), owing to its inventory of strong growth projects, restructuring initiatives and healthy financial profile. These positives are somewhat negated by the its high exposure to the downstream business, major natural gas focus, as well as lofty capital spending, which may result in reduced returns going forward.

Based in Netherlands, Shell 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.

The company’s diversified portfolio of global energy businesses offer attractive long-term growth opportunities, while a number of development projects and increased capital expenditures are expected to aid in volume growth over the long haul.

Shell has 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 some 25% by 2017-2018 (from 2011 levels), driven by a new wave of project startups.

Shell’s targeted output advance represents one of the most ambitious growth programs in the sector, which will be achieved primarily by new projects coming on-line in Qatar, Australia and North America. The company is currently assessing more than 60 new projects and options that should guarantee robust upstream growth by 2020.

Additionally, in view of the bearish outlook for the marketing and refining operations, Shell decided to streamline its downstream portfolio. The company has been looking to improve its performance and remain competitive in this difficult environment by embarking on aggressive cost reduction steps, exiting unprofitable markets and streamlining the organization.

Shell is also a frontrunner in the liquefied natural gas (LNG) and Gas-to-Liquids (GtL) technologies spaces, backed by years of research and development, extensive expertise, multi-billion dollar investments and cordial relationships with partners/governments worldwide.

However, being one of the largest integrated oil and gas companies in the world, Shell is particularly susceptible to the downside risk from the current turmoil in the global economy.

Shell is the most gas-focused among the major companies in the sector, with 48% of its current production from the commodity. Given natural gas weak fundamentals, this remains a key area of concern, in our view.

Moreover, Shell projects an investment of some $30 billion in 2012, quite high by industry standards. This is expected to substantially improve the group’s leverage and deteriorate its credit metrics during the current downturn. Additionally, the increasing capital intensity of its operations may result in reduced returns going forward.

Shell – the second biggest oil company by market capitalization after ExxonMobil Corp. (XOM - Analyst Report) – currently retains a Zacks #3 Rank that translates into a short-term Hold rating.