City analysts following oil major Royal Dutch Shell (LSE: RDSB) (NYSE: RDSB.US) expect earnings to increase by 42% this year. Growth like that isn’t found every day on the stock market, so that makes Shell a great candidate for a growth investment, right?
I don’t think so. Earnings are up this year, true, but last year they fell by 39% — welcome to the see-saw world of the cyclical companies.
Selective approach
The fluctuating price of hydrocarbon products such as oil and gas determines the output-selling price for Shell’s upstream operations. That makes earnings volatile and, during 2013, a combination of lower cash in-flow from operations and higher capital investment came together to create the earnings’ decline. In 2014, earnings look set to bounce back, but such cyclicality, and the firm’s sensitivity to wider macro-economic cycles, leaves Shell wanting as a growth proposition.
Looking forward, the firm aims to improve investor returns by focusing on what it describes as better financial performance, enhanced capital efficiency, and strong project delivery. The strategy involves a selective approach to project execution and some $15 billion of planned divestments during 2014-15.
Shell’s growth targets could see around 30 major projects add about seven billion barrels of oil, or gas equivalents, to its reserves, which could improve cash flow by $15 billion before the end of 2015 if the oil price holds at about $100 per barrel. To put that in perspective, Shell generated just over $40 billion of net cash from its operations during 2013, so we’re are looking at an estimated 38% or so improvement.
Building assets
A natural resources firm such as Shell needs to grow its asset base, its reserves in the ground, if the share price is to take off. In essence, Shell hopes that a smart approach to managing its assets will drive up the value of its reserves.
Here’s the firm’ record on net asset value per share:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Net asset value per share (cents) | 2,168 | 2,360 | 2,680 | 2,742 | 2,809 |
That’s an almost 30% increase over four years. If Shell can keep growing its assets, there could be some forward growth for shareholders to capture. However, Shell’s performance on delivering total returns will always be subject to the cyclicality inherent in the industry, which could fight against the outcome for investors.
What now?
Royal Dutch Shell has plans for growth but will always face a two-steps-forward-one-back outcome thanks to the cyclicality of the business. That’s why the firm might not be the best growth selection on the London market.
