Why I’d ditch this falling knife to buy Royal Dutch Shell plc

Royal Dutch Shell plc (LON:RDSB) could climb further than you expect, says Roland Head.

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When do you sell a losing position? Shareholders of food production biotech group Benchmark Holdings (LSE: BMK) were probably asking that question on Friday morning, when management backtracked on previous guidance and triggered a 14% share price fall.

The company’s shares have now fallen by 47% this year. Should shareholders simply ditch this disappointing stock before things get worse?

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What’s gone wrong?

One of the firm’s big hopes is a new treatment for sea lice, which have become a serious problem for producers of farmed salmon. Back in June, the company said commercial trials were due to start “in the coming weeks”. The product was expected to contribute “significant revenues” in the second half of the year.

Unfortunately, this hasn’t happened. In Friday’s update, we learned that the trials have still not started and are unlikely to do so before the end of September when the company’s financial year ends. This means the new product won’t make any contribution to revenue in the 2017 financial year.

This is disappointing as revenue from the new product was expected to offset falling sales of Benchmark’s older sea lice treatment Salmosan. This decline is serious. Sales in the group’s Animal Health division fell from £12.2m to £7.1m during the first half of this year. The division’s operating loss doubled from £3.2m to £6.7m during the same period.

Full-year outlook

Profit forecasts for 2017 were slashed in November last year, after the group warned of delayed investment and lower growth rates in certain sectors. Friday’s news is another disappointment.

Benchmark reported a pre-tax loss of £22.4m last year. Analysts expected the group to report adjusted earnings of 0.68p per share this year. But even if these forecasts are left unchanged, the stock still trades on a forecast P/E of 66. There are big hopes for 2018, but I don’t think the shares are cheap enough to be worth the risk.

I’d buy this instead

Benchmark’s management has promised more than they can deliver. By contrast, Royal Dutch Shell (LSE: RDSB) chief executive Ben van Beurden has delivered exactly what he promised.

Mr van Beurden has reduced the group’s net debt, improved cash flow and made good progress with planned asset sales. At about £22, Shell’s share price has risen off the lows of £14 seen at the start of 2016. But I think the stock still offers a useful amount of upside

The acquisition of BG Group is starting to look like a smart move, and the stock still offers a dividend yield of around 6.4%. This payout should be covered by earnings this year. In my opinion, this pretty much eliminates any risk of a dividend cut.

What about upside?

All of that is fair enough, but with Shell trading on a forecast P/E of 14.8, surely potential gains are limited? I’m not so sure. I believe the final stage of the oil and gas group’s recovery will come when the price of oil rises to a more sustainable level.

The extensive cost-cutting that’s taken place across the industry means that a fairly small increase in the price of oil could drive a big increase in profits. I believe this is inevitable at some point in the next year or two. In the meantime, this 6%+ dividend yield continues to reward patient shareholders.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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