Buy Shell After Eagle Ford Selloff

by Aaron Levitt | October 2, 2013 6:30 am

Sometimes even prominent companies can have a hard time turning profits from a seemly can’t-miss situation. In this case, we’re talking about international energy giant Royal Dutch Shell (RDS.A[1]) and the prolific Eagle Ford Shale.

The Eagle Ford has been a source of abundant crude oil and natural gas liquids for countless operators — both big and small — and single-handedly changed the economic fortunes of South Texas and the United States. And yet, it seems that Shell couldn’t find its mojo in the region. Now, the integrated giant is pulling out of the field via a massive asset sale.

Believe it or not, Shell’s decision to sell out could actually be a good thing. As we’ve noted[2] here on InvestorPlace before, being smaller and more nimble could lead to larger profits down the road. For investors, it may be time to revisit the integrated giant.

$2 Billion Write-Down

Despite having more than 106,000 acres to work with and nearly operating 192 wells in the region, Shell just couldn’t seem to get the Eagle Ford to work for its needs. Citing size and scalability issues, the company has decided to put the holdings up for sale.

Wells in the Eagle Ford produce approximately 32,000 barrels of oil equivalent per day. Shell will continue to operate around 150 production wells[3] in region while allowing potential buyers to review technical data on the holdings. Additionally, the firm also said it plans to sell 600,000 acres at the Mississippi Lime formation in Kansas.

The asset sales come on the back of a huge $2.2 billion write-down on the value of its North American assets as well as a 60% drop in profits back in August.

It seems that Shell was late to the shale party, having purchased these Eagle Ford assets back in 2010 — just when the market was peaking. Since that time, the glut of natural gas took much of the wind out of Shell’s production, and causing profits to fall.

Following the lead of other “latecomer” producers — like BG Group (BRGYY[4]) and BHP Billiton (BHP[5]) — Shell took impairment charges against the value of their U.S. shale assets. Essentially, the oil leviathan overpaid for lower quality assets in the region, and that’s not the first misstep Shell has had recently.

But the company has realized its mistakes and has begun the process of getting “smaller.”

As we’ve seen, smaller is better[6] when it comes to big energy profits. The prevailing idea used to be that, in order to be successful, an energy stock had to control every part of the cycle — from the wellhead to the gas tank. Becoming integrated was the key to dominance and shareholder returns.

That old idea has fallen flat as smaller, nimbler firms have taken the old integrated giants to the woodshed across many fronts. Spinoffs and asset sales are now the norm for the former giants, and that’s helping in the returns department as several leaner and meaner energy stocks are finally producing stellar results once again.

Taking a cue from former integrated firms like ConocoPhillips (COP[7]) and Marathon (MRO[8]), Shell seems to be setting itself up for similar splits of its businesses. Already, Shell has disposed around $4 billion[9] in assets since June 2013. Over the last three years that number is in the $21 billion range.

However, more could be on the chopping block. Especially given that Shell said in its latest earnings release that it was “entering a new phase of more substantial portfolio change, which will lead to a higher rate of divestments in the coming years”.

Shell has already pledged that its Nigerian assets are under strategic review, while analysts predict that its long-troubled fields in Alaska’s frozen seas and Colorado could also be on the table for potential sales. Also on the sell-block could its chemicals business and its joint venture with Cosan (CZZ[10]) that makes ethanol in Brazil from sugarcane.

A Good Thing for Shareholders

After going on a huge buying binge — spending about $100 billion over the last few years — Shell’s reversal towards asset sales is certainly refreshing. More importantly, that trend could be worth some serious dough to shareholders. Wall Street cheered French rival’s Total’s (TOT[11]) recent restructuring efforts, and it already seems to be riding high on Shell’s preliminary maneuvering.

Goldman Sachs moved shares of the Anglo-Dutch firm up three spots from “sell” to “buy” based on the news of the asset sale. Goldman cited Shell’s exposure to long-life assets that throw off tons of cash flow that will be the focus of its restructuring efforts. To that end, it also upped its price target [12]to $71 per share.

I tend to agree with those assessments. By becoming nimbler and selling off underperforming assets by the bucket, Shell shareholders will be amply rewarded with future earnings growth and cash flows[13]. And getting rid of problem assets will free up the “good” assets to shine brightly, which will help shares trade at higher multiples.

Until then, shares of the firm are trading at bargain-bin prices. U.S.-listed shares of Shell have lost around 5% year-to-date, while the broad Energy Select Sector SPDR (XLE[14]) is up around 17%. That has left shares trading at a P/E of less than 9. That’s less than former integrated rivals like ConocoPhillips, and comes with a juicy dividend of more than 5%.

If you like Shell’s prospects, buy quickly — given the company’s newfound focus, that cheap price may not last long.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. RDS.A:
  2. As we’ve noted:
  3. 150 production wells:
  4. BRGYY:
  5. BHP:
  6. smaller is better:
  7. COP:
  8. MRO:
  9. $4 billion:
  10. CZZ:
  11. TOT:
  12. upped its price target :
  13. earnings growth and cash flows:
  14. XLE:

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