How Will Royal Dutch Shell Plc Fare In 2014?

For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.

That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.

To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:

  • Prospects;
  • Risks;
  • Valuation.

Today, I’m looking at oil giant Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US).

Track record

With the shares at 2204p, Royal Dutch Shell’s market cap. is £54,464 million.

This table summarises the firm’s recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue ($m) 458,361 278,188 368,056 470,171 467,153
Net cash from operations ($m) 43,918 21,488 27,350 36,771 46,140
Adjusted earnings per share (cents) 509 160 304 461 432
Dividend per share (cents) 160 168 168 168 172

1) Prospects

In a recent third-quarter update, Shell revealed a 5% decline in operating cash flow for the first nine months of its trading year. Headwinds from weak industry refining margins and the security situation in Nigeria didn’t help, and the firm expects those factors to further erode the near term outlook. However, the CEO reckons the company has a strong project flow in place for 2014 and beyond that will drive Shell’s cash flow in 2014 and beyond.

Shell’s growth agenda could see around 30 major projects add about seven billion barrels of oil, or gas equivalents. The company thinks that such upstream activity is capable of boosting cash flow by $15 billion before the end of 2015 if the oil price holds at about $100 per barrel.

The company sees the dividend as the main route for returning cash to shareholders and reckons it distributed more than $11 billion of dividends in the last year or so. There’s also an active share-repurchase programme designed to drive up earnings- and dividend-per-share figures with the firm targeting a $5 billion buyback spend in 2013.

2) Risks

At the risk of stating the obvious, Shell is a commodity-type business. By that I mean a business characterised by little pricing power and zero product differentiation. In other words, the firm’s profitability relies on the prevailing price of the commodity it sells into the market. That makes the firm particularly vulnerable to the supply and demand equation and I think we can see the effects of economic cyclicality in the table above.

If the price of oil falls, the expected cash-flow outcome may not materialise despite operational progress and that could jeopardise dividend returns for investors.

3) Valuation

A forward dividend yield of 5.2% for 2014 looks attractive. City analysts expect forward earnings to cover that dividend just over twice and you can pick up the shares on a forward P/E multiple of around nine, which sits well against 10% earnings-growth predictions.

What now?

Shell’s dividend looks attractive, but the potential for commodity prices to fall puts me off.  

Instead, I'm looking at five companies with strong economic franchises and seemingly well-defended operating niches analysed in a well-researched Fool report.

Unlike Royal Dutch Shell, these firm's have greater ability to control pricing, which makes their businesses less vulnerable to cyclical trends. I recommend the five shares for your own due diligence and research, as they surely deserve consideration by investors aiming to build wealth in the long run. To download the report click here.

> Kevin does not own shares in Royal Dutch Shell.