Shares in Shell (LSE: RDSA) (LSE: RDSB) (NYSE: RDS-B.US) are up by 1% today despite the oil major reporting a fall in net income of 56%, with it declining to $3.2bn in the first quarter of the year. This, though, was ahead of market forecasts of $2.4bn, with investors being well aware of the hugely negative impact that a lower oil price is having on Shell and the wider sector. In fact, Shell has had to deal with a 50% fall in the oil price and a gas price that is around a third lower than in the first quarter of the prior year, and so the large falls in its bottom line are very much in line with wider industry performance.
Business Model
A key reason why Shell’s figures were better than expected, though, is its relatively diverse business model. For example, its refinery division has held up well even during the volatile period for oil prices, with its profitability improving from $1.6bn in the corresponding quarter last year, to $2.7bn in the most recent quarter. And, crucially, Shell has only reduced production by a relatively small amount and this could also help to maintain the company’s market share and deliver relatively strong profitability moving forward.
Looking Ahead
Still, a lower oil price inevitably means lower profit for Shell and, as a result, the company has provided updated guidance on its capital expenditure plans. It will cut capex in 2015 from its previous planned figure of $35bn to $33bn. This, though, is only a relatively small cut and shows that, while Shell may be responding to a lower oil price, it does not appear to be of the view that the current oil price level will remain in the medium to long term. Otherwise, it is likely that a further cut to capex would have been made.
Growth Potential
Of course, today’s update confirms that 2015 is set to be a tough year for Shell. In fact, for the full year, the company is forecast to post a fall in its net profit of 36%, which is reflective of a weaker oil price. However, next year Shell is expected to return to growth, with its bottom line set to rise by 35% and, moreover, the current year’s difficulties appear to be adequately priced in to the company’s valuation. Evidence of this can be seen in Shell’s price to earnings growth (PEG) ratio, which stands at just 0.3 and indicates that a wide margin of safety is built in to the company’s share price.
And, with Shell’s rationalisation plans moving ahead at a rapid rate (it has already sold $2bn of assets in the first part of this year as it seeks to retain only its most lucrative businesses) and the expected improvement to its asset base from the acquisition of BG, now could be a good time to invest in the oil major. Certainly, things may get worse before they get better, but with a diverse business model and a keen valuation, Shell holds considerable promise for long-term investors.