Image Source: Royal Dutch Shell via flickr.com.
Shareholders in Big Oil stocks like Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B) are looking for stable dividend payers that may not grow share prices at rapid rates, but should be somewhat protected from major declines. That hasn't been the case lately as Shell's stock has declined more than 45% from their highs in July of last year.
Despite the challenges Shell and others are facing with low oil prices today, there are some things the company are working on what could help regain these losses over the past year or so and potentially send the stock surging again. Here are three potential catalysts over the next few years that could send Shell's share price surging again.
Keeping its spending in check
Just recently, Shell announced that it had suspended its Arctic drilling program off the coast of Alaska. I'm sure there will be plenty of talking heads who will discuss the political ramifications and all that, but the bottom line is that the company hasn't found enough oil there to justify continued work there based on its projections for oil prices. If oil were north of $100 a barrel today, chances are they would continue that work.
But with oil prices remaining low so far this year and projections for oil prices over the next couple of years not looking as robust as they did just a year or so ago, Shell has been forced to make hard choices like this one to balance its spending and its ability to generate cash from its current operations.
The one thing that Shell does have going for it on this end is that it has brought several major projects online over the past couple of years, which has allowed it to reduce capital expenditures from their peak in 2013 of over $40 billion to an estimated $30 billion for the year. Furthermore, the company is looking to cut more than 10% of operational expenses from last year, which could save the company more than $4 billion annually.
If the company can shave that much off its operational budget as well as rein in spending on some of its less profitable ventures, it should help to boost profits and cash flows, something that could be well rewarded by shareholders looking to any sort of sign of improvement for oil companies.
Strong execution post-BG buyout
By now, most investors know that the record for companies making huge acquisitions isn't great. For every success story there is another that showed how the a merger can kill capital. That is part of the reason that some investors have been rightly tepid about the proposed $70 billion deal to acquire BG Group (NASDAQOTH: BRGYY). Of course, the argument against is that Shell may have overpaid for a company that doesn't have a whole lot of overlaps in terms of production sources, and chances are that there will be several asset sales where there isn't a whole lot of operational overlap.
Data source: Royal Dutch Shell investor presentation.
The argument for the deal, though, is that the two companies overlap significantly where it counts to the two companies, most notably in deepwater Brazil and LNG. Both Shell and BG Group were some of the biggest bidders to work with Petrobras (PBR 0.72%) in the pre-salt deepwater basins, and the combined position of these two companies in this region could almost triple to 600,000 barrels per day by the end of the decade if development plans stay on track.
Data source: Royal Dutch Shell investor presentation.
On top of that, the combination of Shell and BG Groups LNG production, trading, and regasification assets will make it the largest LNG supplier among its integrated oil and gas peers by a long shot.
Data source: Shell investor presentation.
History has taught us, though, that mergers don't always go as planned, and there are lots of places where this one could go wrong. In 2014 and 2015 alone, Shell is looking to sell $20 billion in assets, and that asset sale trend is expected to continue to right size its portfolio after adding BG Group to the mix. If the company can realize the benefits of combining Shell's and BG's businesses and eke out some cost savings through more efficient operations, then this could end up being a big win for Shell that could go a long way in boosting the company's stock for several years to come.
$25 billion share buyback
Shell seems to think that following all of the moves that it's making to right size the portfolio and control spending will result in a windfall of cash. As part of the plans it has laid out, it anticipates that it will generate enough cash that it will be able to do a $25 billion stock repurchase program between 2017 and 2020. At today's prices, that would equate to retiring 15%-20% of the company's total shares outstanding.
What really makes this offer intriguing, however, is that Shell is trading at historically low levels. Since oil and gas are cyclical commodities, it can be hard to value a company's stock with earnings based valuations, but one that is more consistent is price to tangible book value because it compares current prices to the underlying assets value of the company. Using this metric, share of Shell haven't been this cheap in a decade.
Basically, what a price to tangible book value of less than 1 means that the market value for a company's underlying assets -- after accounting for debt -- is less than what the company's balance sheet says they're worth.
So, let's say Shell's share price stays low for a while because we don't see a significant boost in oil or gas prices for a couple years. This means that the company could have the potential to buy back shares at decade lows -- something that could go a long way in boosting shareholder returns over the long run.
It may take the market a long time to realize the benefits of this massive share repurchase program, but the combination of a lower share count and a modest increase in oil prices could really boost per-share earnings and, with it, stock prices.
What a Fool believes
Aside from the most obvious aid for Royal Dutch Shell's stock -- oil prices -- there are some things that the company is doing to help its shares. Slashing its budget and incorporating BG Group effectively could go a long way in boosting overall profitability for the company, and buying back boatloads of shares over the next two to five years will help turn those earnings boosts into even larger per-share profits. It may take a while for all of these things to happen, but as they do, they have the potential to send shares of Shell surging much higher than where they are today.
