At the beginning of this year, Royal Dutch Shell (LSE: RDSA) (LSE: RDSB) (NYSE: RDS-B.US) issued its first profit warning in a decade, shocking the market.
However, Shell’s management is now on the warpath and is taking action to ensure that the company returns to growth. The question is, should you buy into Shell’s recovery plan?
Trouble children
The majority of Shell’s troubles can be traced back to its refining and North American businesses, where the company is suffering from razor-thin profit margins and high costs.
Indeed, last year Shell’s North American operations reported a loss of $900m, down from a profit of $670m during 2012, thanks to falling natural gas prices and rising exploration costs. Shell has around $80bn worth of capital assets within the US, so a loss of $670m is extremely disappointing for the company. Overall, Shell’s assets are worth £220bn, indicating that 23% of the company’s assets are losing money.
What’s more, Shell has been forced to write down the value of some North American assets, which has cost the company a total of $2.5bn. It’s also estimated that the company has invested at least $24bn developing unconventional oil plays on the continent, with little to show for it.
Meanwhile, Shell’s refining business is currently trying to grapple with contracting profit margins, although refining tends to be a cyclical business and stronger profits should follow when the market recovers.
Shell’s plan of action
Fortunately, Shell’s management has not turned a blind eye to these problems and is trying to get the company back on a stable footing again. Specifically, management intends to divest $15bn of assets over the next two years and lower capital spending. Spending is expected to be 20% lower during 2014.
The company has not wasted any time getting on with the job. So far, Shell has halted work on a new gas-to-liquids plant and has postponed an investment in the Arrow LNG project, saving billions. Additionally, Shell has sold underperforming assets within Nigeria, the North Sea, Brazil, and Australia.
Nevertheless, as Shell has only promised to divest $15bn of assets, roughly 3% of the company’s overall portfolio, some City analysts believe that the company will have to make further cuts to jump start profit growth again.
Is the risk worth the reward?
So, is it worth taking a bet on Shell’s turnaround plan? Well, despite Shell’s recent troubles the company remains almost debt free, is profitable and offers an attractive and well covered dividend yield. Actually, Shell’s management has promised shareholders that bigger dividend payouts are on the cards when the company returns to growth.
Overall then, it would appear that there is very little at risk in Shell’s turnaround plan, but the rewards are extremely attractive.
