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3 Reasons Why You Might Think Of Investing In This FTSE Underdog: Royal Dutch Shell Plc

Contrarian investors like to find stocks that are out of favour with the market. When sentiment is negative, then the true value of a stock can easily be overlooked. I’m trawling the underdogs of the FTSE to identify which of them may not deserve their sub-market PE ratings.

Shell (LSE: RDSB) (NYSE: RDS B.US) has made a habit of disappointing investors. In the summer the interim results were marred by a $2bn write-off on the value of US shale deposits, which helped push half-year profits down by a quarter.

The recent third-quarter results piled on the misery. Earnings were a third lower than the same period last year due to higher operating and exploration expenses, the deteriorating security situation in Nigeria and poor results from the downstream refining business, which suffers from weak demand and overcapacity.

Capex

Overlaying these specific problems, the City thinks Shell over-spends on capex, chasing ambitious production targets at the expense of profitability. So far this year $26bn of the firm’s $34bn after-tax cash flow went on capex, with just $10bn returned to shareholders.

Perhaps it’s no wonder that CEO Peter Voser announced mid-year that he would leave in 2014. His successor was a surprise appointment. Ben van Beurden is a lifetime Shell employee who was only promoted to running the downstream operations in January 2013. A year later he’ll be running the whole show.

Optimistic

Nevertheless I remain optimistic about Shell and, with its sub-10 P/E and 5%+ yield, I am happy to add to my holding on the dips.

Firstly, Shell has some tremendous assets. It’s one of the biggest players globally in liquefied natural gas with several long-life projects generating strong cash flow; it’s a specialist in deep-water exploration and production; and it has built up a good position in unconventional resources.

Secondly, Shell is undervalued because of the City’s short-term focus.  It’s the cheapest of the western oil majors, reflecting disappointment with quarterly results in an industry where planning horizons stretch to decades.  Current capital expenditure should generate profits far into the future.

Thirdly, a change of management should catalyse moves that will please the institutions. There won’t be any significant changes under an outgoing CEO. The new man might make his mark with initiatives such as more focused capital allocation, accelerated assets sales, operational reorganisation and increased shareholder returns.

Exciting

Shell is a behemoth in the oil and gas sector and a great long-term hold. But, as investment guru Jim Slater said, elephants don't gallop. If you're looking for more exciting investments in the sector, I recommend you take a look at 'How to Unearth Great Oil and Gas Shares'.  It's an exclusive report from the Motley Fool packed full of tips. It costs nothing to download and might just give you some useful ideas. Just click here.

 > Tony owns shares in Shell.