Why Investing in Royal Dutch Shell plc Requires Patience

Royal Dutch Shell's interim fourth-quarter updated contained bad news across the board. Investors need to brace themselves for when Shell reports later this month.

Jan 27, 2014 at 1:17PM

Big Oil has its fair share of complications these days, spanning from weak refining margins to severe security challenges across the world. No company is suffering more from these issues than Royal Dutch Shell (NYSE:RDS-B), which released an interim fourth-quarter update that should give investors pause.

That's why Foolish investors need to exercise a good deal of patience when it comes to Royal Dutch Shell. Its near-term results are likely to be sluggish at best, and all indications are it will take some time for Shell to sort out its problems.

Lower profits on the horizon
Royal Dutch Shell will report its fourth-quarter and full-year results on January 30. Meanwhile, the company released an interim update, to give investors fair warning that the results won't be pretty. To use Shell's own words, "fourth quarter 2013 figures are expected to be significantly lower than recent levels of profitability, considering current oil and gas prices and the downstream oil products industry environment."

In all, Royal Dutch Shell expects earnings of $2.2 billion and $16.8 billion in its fourth quarter and full fiscal 2013, respectively. This compares very poorly to the same results in 2012. Shell earned $7.3 billion in core earnings in the fourth quarter last year and $27.2 billion in 2012.

It's not entirely difficult to see the reasons for Royal Dutch Shell's struggles. It's seeing weakness across nearly all of its businesses. First, the price of Brent crude, the international equivalent to West Texas Intermediate crude, recently fell to a two-month low on resumed Libyan supply. In addition, Shell encountered higher exploration expenses, higher maintenance requirements, and lower volumes.

On the downstream side, earnings continue to be affected primarily by weak refining conditions, especially in Asia-Pacific and Europe. Chemicals earnings are expected to increase, but this will be more than offset by broader refining woes.

This isn't necessarily a surprise, as refiners have languished for most of 2013. Major refiner Valero Energy (NYSE:VLO) reported a 53% drop in third-quarter net income, from $674 million in 2012 to $312 million in 2013. Collapsing refining profitability is due to shrinking margins, and it's likely Shell will report similar conditions in its own refining unit.

Add it all up, and Shell projects worsening results in each of its upstream, downstream, and corporate activities segments.

Shell follows a familiar trend
The issues facing Royal Dutch Shell are rippling through the entire industry. Fellow integrated major Chevron (NYSE:CVX) expects its fourth-quarter results to be similar to those from the third quarter. That's not saying a whole lot in Chevron's favor, since its third-quarter net income fell 5% versus the same period the year prior. At the same time, Chevron is displaying far superior resilience compared to Shell.

What makes Shell's situation particularly worrisome is that it's suffering much more severely than its rivals. Everything seems to be going against Shell, but at the same time, there's no guarantee the situation will improve significantly in the near future. For example, the company is under the weight of a serious security challenge in Nigeria that will probably exist well into 2014.

Can management turn things around?
Royal Dutch Shell management admitted its own disappointment in the company's poor results over the course of the past year. In its fourth-quarter interim report, CEO Ben van Beurden stated: "Our 2013 performance was not what I expect from Shell. Our focus will be on improving Shell's financial results, achieving better capital efficiency and on continuing to strengthen our operational performance and project delivery."

Investors will have to decide if they believe management will be successful in engineering a turnaround. To the company's credit, Shell pays a dividend that places it near the top of its industry. Its dividend might be the only thing investors can count on over the next year, as significant stock price appreciation might be too much to ask given Shell's multitude of problems.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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