Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
Today, I’m considering whether FTSE 100 oil major Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) is a wonderful company, and whether its shares are trading at a fair price.
A wonderful company?
An oil firm isn’t exactly the big-brand business with great pricing power that we think of as the quintessential Buffett “wonderful company”. However, the master investor’s Berkshire Hathaway investment company has flirted with Big Oil in the recent past — in fact, with the biggest of the big: US giant Exxon Mobil.
The history of Berkshire’s Exxon holding is curious. Berkshire purchased a relatively modest $100m worth of shares during the third quarter of 2009, reduced the holding the following quarter, and exited completely during the fourth quarter of 2011.
The final disposal came shortly after Exxon announced a mega-billions Arctic oil exploration and development agreement with Russian state-owned oil company Rosneft, putting Exxon up to its neck in Russia’s risky business environment. Buffett has spoken of Russia as a risk nightmare for western investors in the past.
Shell has long had interests in Russia. Despite some less than happy experiences, the company has waded deeper into the territory this year, announcing — like Exxon — a mega-billions Arctic oil exploration and development agreement with a Russian energy giant: in Shell’s case, Gazprom.
Buffett is currently invested in three other oil companies: ConocoPhillips, Phillips 66, and Suncor Energy. The profiles of these firms don’t appear to me to offer a positive read-across to Shell as a wonderful company.
US group ConocoPhillips is a pure-play exploration and production company, having spun off its refining arm into Phillips 66. And while Shell has been pushing further into Russia, ConocoPhillips has been pulling out.
Meanwhile, in going outside the US for an integrated oil company, Buffett didn’t head for the supermajors of the UK (BP and Shell) or France (Total), but to the smaller Canadian group Suncor Energy. Suncor’s upstream business is focused on Canada’s Athabasca oil sands, where it was the first developer and holds one of the largest positions. The company’s downstream operations are also focused on Canada.
A fair price?
It strikes me that, in Buffett terms, Shell is a fair company trading at, arguably, a wonderful price (single-digit P/E and dividend yield above 5%). But we know what Buffett thinks: “It’s far better to buy a wonderful company at a fair price”.