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Don’t Sleep on Royal Dutch Shell (RDS.A, RDS.B)

One of the biggest stories of 2015 has been the pain in American energy stocks. But that pain isn’t exclusive to the States — European giant Royal Dutch Shell (RDS.A, RDS.B) just reported earnings, and like many of its peers, the profit front doesn’t look great.

Royal Dutch Shell NYSE:RDS.A NYSE:RDS.BThe latest earnings report from RDS is a reflection of just how bad oil prices have been, and how badly profits are being crimped.

Still, there’s hope for Royal Dutch Shell. The company’s ongoing acquisition plans — as well as continued cost cutting — could turn the tide and make RDS stock worthy of a buy.

A Big Slip in Profits for Shell

RDS reported drastically lower profits for its second quarter. Adjusted earnings of $3.4 billion came in about 33% lower than the year-ago period’s $6.1 billion. On a per-share basis, Royal Dutch Shell’s $1.20 in profits easily beat Zacks estimates of 93 cents, however.

That huge drop in profits rests on average lower oil prices and lower production volumes with regards to its upstream unit. For the quarter, Shell saw its average price per barrel of crude oil slip by 43% year-over-year. Likewise, natural gas realizations tanked 31%.

The lower oil prices cut about $3.7 billion in earnings from its E&P unit. Meanwhile, volume of production declined by 11.2%, with both natural gas and oil production slumping.

The bright spot for Shell was once again its refining unit. The benefit of being integrated is that your chemical, petroleum refining and other downstream activities can feast on lower oil prices. The sector has been able to enjoy some of the largest crack spreads in recent times. RDS managed to nearly triple its profits in its refining business as a result of lower oil/natural prices. Unfortunately, the gains here weren’t enough to completely counteract the problems at it upstream unit.

With the fall in profits, RDS announced it would lay off 6,500 workers in an attempt to reduce costs. Capex also was reduced by $7 billion to help on that front.

Here’s Where It Gets Good for RDS

Big-picture, there’s one positive that investors should hone in on: Royal Dutch Shell’s $70 billion mega acquisition of BG Group (BRGYY).

While Shell was suffering this quarter, BG managed to report record production of natural gas, oil and liquefied natural gas as well as a profit increase. Production jumped 19% to 703,000 barrels of oil equivalent per day. BG also managed to sell 3.6 million metric tons of LNG — an increase of eight cargoes’ worth versus last year. These increases help BG beat expectations and see a 63% jump in its profits in the quarter vs. last year at this time.

BG’s record production is huge news for Shell — and it highlights exactly why RDS wanted the firm in the first place.

Shell is already the leading producer of LNG in the world. (It actually created the technology needed for the first LNG plant 50 years ago.) Similarly, BG is no slouch, and has all the required complex infrastructure needed to produce, ship and use LNG from the well head to the generator.

The two fit together perfectly.

Secondly, BG’s portfolio of production assets is just what Shell needs to help turn the tide of its falling production. BG has assets spanning the globe, including rich holdings in Brazil, Africa, Australia, the North Sea and Egypt. Those assets should help BG produce an average of 650,000 to 690,000 BoE per day this year. Those barrels would immediately help Shell on the production front and also allow it cut capex spending on exploration.

In fact, the buy-out will allow Shell raise money. Shell has already identified around $30 billion worth of non-core and redundant assets that it can get rid of once the deal closes.

So Is RDS Stock a Buy?

At this point, everyone knew we were going to see lower profits this quarter. That’s why RDS wasn’t taken to the woodshed (in fact, it jumped in Thursday trading).

Longer-term, the BG deal is going to be sweet for RDS stock holders. The added production, cash flows from LNG and cost savings potential are exactly what the suffering major needs to outperform its rivals in the integrated energy sector. And like most energy companies, RDS shares have been battered — the stock is some 30% cheaper from June 2014 prices, which has also driven its yield up to north of 6%.

Ignore the earnings slump. RDS.A and RDS.B should regain their mojo as BG continues to fire on all cylinders.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2015/07/rds-royal-dutch-shell-earnings-q2/.

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