Valuation - Royal Dutch Shell PLC
A Valuation of Royal Dutch Shell PLC (LON: RDSB) on 4 November 2020
The Company
Royal Dutch Shell PLC, usually called Shell, is a multinational oil and gas company. It is one of the oil and gas supermajors and the third-largest company in the world measured by 2018 revenues (and the largest based in Europe).
Shell is vertically integrated and is active in every area of the oil and gas industry, including exploration and production, refining, transport, distribution and marketing, petrochemicals, power generation, and trading. It also has renewable energy activities, including biofuels, wind, energy-kite systems, and hydrogen and is aiming to be carbon-neutral by 2050.
Shell reports in USD and I have valued the shares in USD.
The Story
In recent decades gas exploration and production has become an increasingly important part of Shell's business. Shell acquired BG Group in 2016, making it the world's largest producer of LNG, with integrated gas becoming an increasing focus of the business (~12% of revenues).
Most of the oil & gas demand lost in 2020 is expected to be recovered by 2022, supplemented by growth from emerging markets as they recover economically and benefit from attractive prices. Mature markets, which were the hardest hit in 2020, are also expected to recover most of their consumption losses by 2022 as demand from the industrial and power generation sectors gradually returns. Some marginal gains are also expected from coal-to-gas switching, which is helped by low gas prices and ample supply.
The EIA predicts that, by 2025, the average price of a BOE will rise to $65-79. By 2030, total global demand is expected to drive prices to $79-98/BOE. By 2040, prices are projected to be $146/b. By then, the cheap oil sources will have been exhausted, making it more expensive to extract oil and by 2050, oil prices are expected to be $214/b. Further, the EIA assumes that demand for petroleum flattens out as utilities increasingly rely on natural gas and renewable energy. It also assumes the global economy grows around 2% annually on average, while energy consumption increases by 0.4% a year.
In order to capture the effects of different oil prices on the value of the business I have forecast using a log-normal distribution of BOE price scenarios and timelines and have assumed that the industry will eventually fall into a slow-burning structural decline. Interestingly, the breadth and diversity of Shell’s assets and vertical-integration of their business lines make Shell uniquely resilient to dramatic price scenarios. A linear regression of operating margins against average historic oil prices reveals a relatively modest 0.7 correlation and 0.09% slope coefficient.
Finally, Ben van Beurden (CEO) and Jessica Uhl (CFO) have signalled their desire to reduce the businesses debt and increase distributions over the coming few years. This plan actually makes sense despite their capital-structure already being optimal. By reducing leverage, the firm will ever so slightly increase their cost-of-capital, but will significantly reduce their distress likelihood in most of the low-price scenarios I have modelled.
Valuation, Sensitivity & Rating
Market Price: $12.97
Est. Value: $17.87
Rating: ‘Buy’
Monte-Carlo simulation suggests that the shares have a 25th percentile value of $16.02 and a 75th percentile value of $19.56.
I give each stock a rating based on where the current price is, as a percentile, on the valuation distribution. The current market price for RDSB is below the 10th percentiles of values so has a rating of ‘Buy’.
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