The Stock Picker's Guide To Royal Dutch Shell Plc

Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you've covered all the bases.

In this series I'm subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Shell (LSE: RDSB) (NYSE: RDS-B.US) measure up?

1.Prospects

The oil price is driven by supply and demand for oil, which in turn is affected by geopolitics and the health of the global economy. The costs of production, and massive capital expenditures involved in exploration, complete the financial dynamics.

Shell has mature upstream operations that deliver solid cash flow, and reserves that cover over 10 years of current production.

The company has invested heavily in natural gas and LNG production. Big investment in US shale gas has not (yet) paid off as the glut of supply depressed prices, but it has added to Shell's reserves.

The search for new resources has pushed exploration into deep waters. Shell has under-sea fields in Latin America and Asia with the Arctic as a longer-term project. Reserves declined by 5% last year following a slight decline in 2011.

2. Performance

Revenues and earnings fluctuate, due to the factors listed above. Operating margins have varied between 6.6% and 11.6% over the past eight years, with return on capital between 12% and 33%.

Shell's scale has enabled it to deliver flat or increasing dividend payments throughout that period.

3.Management

Shell's CEO Peter Voser has been with the company for 30 years, becoming CEO in 2009, five years after the company's reputation was tarnished by mis-reporting of reserves. He has driven its geographical and technological diversification, including the push into natural and unconventional gas.

Mr Voser has £20m worth of shares, while the finance director has £10m.

4.Safety

Reserves underpin the company's future cash flow. In each of the past two years, cash from operations has covered the big outflows of tax, dividends and capital expenditure, and allowed for $1bn-worth of share buy-backs.

Net gearing is a low 10%, and tangible net worth is over 80% of market cap.

BP's Gulf of Mexico disaster highlights the operational risks in the oil business. The investigation into oil price-fixing has the potential to grow to LIBOR-scandal proportions, but not for some time.

5. Valuation

Shell's projected price-to-earnings ratio of 8.4 is well below the FTSE 100 average. Its yield of 5% is one of the highest on the market and high for Shell historically.

Conclusion

Reserve replacement and the US oil glut are strong headwinds, but the market seems not to fully appreciate Shell's cash flow machine. It's a core holding for oil and gas investors.

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