Shell‘s (LSE: RDSB) profit declined by 44% in the final quarter of 2016, so it may seem rather surprising that its shares are up 2% today. After all, profit attributable to shareholders falling from $1.8bn to $1bn is a big drop. However, the market had already priced-in a disappointing period for the stock. And with oil prices on the up, Shell’s strategy delivering improved performance and its shares offering excellent value for money, now could be the right time to buy it.
A tough period
Of course, a lower oil price was always going to mean Shell’s profit came under pressure in the latter part of 2016. On a full-year basis, its earnings declined by a more respectable 8%. However, when identified items (such as a charge of $0.5bn relating to deferred tax reassessments) are excluded, the company’s fourth quarter earnings increased by around 14%. This shows that the underlying performance of the business remains sound, especially at a time when Shell is undergoing a major transition.
A changing business
Shell’s short-term performance is perhaps less important than usual at the present time. It’s making major changes to its business model, which include large-scale divestments as it seeks to successfully integrate the assets acquired as part of the BG Group deal. Clearly, integrating such a large business will take time, but Shell is already operating with an underlying cost level which is $10bn lower than the combined Shell and BG business from 24 months ago. Furthermore, its free cash flow has strengthened and in the fourth quarter was sufficient to cover dividends.
More changes lie ahead for the business. It’s still only halfway through its divestment programme and once finished, a leaner, more efficient business should remain. In addition, the successful integration of the BG assets should equate to rapidly rising cash flow over the medium term, which may cause the company’s dividend payments to increase.
Since the price of oil has the potential to move higher this year as demand catches up with supply, Shell’s outlook is relatively positive. It’s forecast to record a rise in its earnings of 85% this year, followed by further growth of 24% next year. This puts it on a price-to-earnings growth (PEG) ratio of only 0.5, which indicates that it offers excellent value for money.
Certainly, the headline reported numbers for the fourth quarter were disappointing. However, Shell continues to perform well on an underlying basis and is putting in place the necessary changes to build a more efficient and profitable business in the long run. While there may be more change and disruption ahead as its divestment programme continues, the company’s strategy appears to be sound. Therefore, now seems to be a good time to buy a slice of it, with capital gains in 2017 and beyond set to be relatively high.
Peter Stephens owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.