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Analyst Blog

On Sep 28, Zacks Investment Research downgraded Royal Dutch Shell plc (RDS.A - Free Report) – Europe’s largest energy producer – to a Zacks Rank #5 (Strong Sell), placing it in the bottom 5% of all stocks that Zacks ranks.

Why the Downgrade?

The commodity price rout has brutalized Shell’s revenues and earnings. What’s more, the outlook remains grim, with fundamentals suggesting that the odds are firmly stacked against a sustained rally. That’s the reason we are predicting a 47% drop in Shell’s EPS this year.

Deep in the red for a long time, the group’s stock price has declined precipitously for good reason. Shares remain down about 8% over the past quarter, and longer-term have dived 31% in the last 24 months – a significant fall considering its status as a ‘blue-chip stock.’

Detailed Analysis

Similar to other companies exploring for and producing oil and gas, the results of Shell’s upstream division are directly exposed to commodity prices. Consequently, with oil price collapsing to a 12-year low of $26.21 in Feb and natural gas unable to breach the key psychological level of $3 per MMBtu, the second-largest oil company by market value after Exxon Mobil Corp. (XOM - Free Report) has seen its revenues, earnings and cash flows hit hard. Shell’s dismal track record of earnings surprise history – lagging estimates in each of the last four quarters – point to its struggles to protect cash flows from the ongoing commodity price weakness.

Moreover, the supermajor is experiencing signs of weakness in the refining business, suggesting that the unit – which saved it when crude prices plunged – could now be a drag. In fact, Royal Dutch Shell’s second quarter downstream unit profits fell 39% from the comparable period of 2015.

As the going gets tough, the integrated major – long considered a safe harbor with a strong balance sheet and substantial dividend – is being forced to offload assets in order to survive the cataclysmic energy-price scenario.

Shell has also found it difficult to digest its $50 billion mega acquisition of BG Group. Apart from the obvious rise in net debt and reduction of liquidity, the combined group's (Shell + BG) capital expenditure stands at $29 billion in 2016, still quite high by industry standards. This is expected to place a substantial burden on the group’s leverage and credit metrics.

As part of the effort to create a leaner structure following the deal, The Hague-based group has promised to liquidate $30 billion worth of assets by 2018. But till date, Shell has been slow to progress on its plan, triggering fears of a shortfall.  

As it is, Shell is suffering from marginal or falling returns, reflecting its struggle to replace reserves, as access to new energy resources becomes more difficult. Given the large base, achieving growth in oil and natural gas production has anyways been a challenge for the company over the last many years.

Royal Dutch Shell's exposure to production in the vulnerable and violence-prone regions in Nigeria poses additional risk.

As a result of these bearish factors, the tendency for a downward estimate revision has been more obvious in recent times. In fact, the Zacks Consensus Estimate for the third quarter has moved down by 6 cents (or 10%) to 57 cents per share over the last 60 days. The Zacks Consensus Estimate for the full year is $1.78, down 17 cents (or 9%) in the same timeframe.

ROYAL DTCH SH-A Price and Consensus

 

ROYAL DTCH SH-A Price and Consensus | ROYAL DTCH SH-A Quote

Stocks That Warrant a Look

While we expect Royal Dutch Shell to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, the entire energy landscape isn't in a decline as there are some interesting choices out there that could be bought. In particular, one can look at CONE Midstream Partners L.P. (CNNX - Free Report) and Ultra Petroleum Corp. (UPLMQ - Free Report) . Both stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Headquartered in Canonsburg, PA, CONE Midstream Partners is a master limited partnership focused on natural gas and condensate gathering in the Marcellus Shale in Pennsylvania, Ohio and West Virginia. It surpassed estimates in each of the last four quarters at an average rate of 19.38%.

Houston, Texas-based Ultra Petroleum is an independent energy firm engaged in the acquisition, development, exploration and production of oil and gas properties. The 2016 Zacks Consensus Estimate for this company is 77 vents, representing 148% earnings per share growth over 2015. The next year’s average forecast is $2.53, pointing to 229% growth

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