Why Royal Dutch Shell plc looks set to be beaten by Mondi plc

The 30 largest firms in the FTSE 100 don't always offer the best investment potential. We can often find better prospects among the 70 or so smaller constituent firms in the index. Today, I'm comparing packaging and paper producer Mondi(LSE: MNDI) with oil giant Royal Dutch Shell(LSE: RDSB).

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A modest valuation

One of the most attractive things about Mondi is its apparently modest valuation. At a share price of 1,354p, the forward price-to-earnings (P/E) ratio runs at just over 12 for 2017 and the forward dividend yield is 3.4%. City analysts following the firm expect earnings to grow 3% that year and to cover the payout around two and a half times.

Mondi's operations in central Europe, Russia, North America and South Africa range from managing forests and producing pulp, paper and compound plastics, to developing industrial and consumer packaging solutions. That sounds like a good depth of vertical integration of the supply chain, which has helped the firm post consistent financial results over recent years:

I like the way cash inflow lends robust support to profits and the fact that both profit and net cash income are both rising steadily. The company seems to have debt under control too. The most recent balance sheet shows gross debt running just under twice the level of annual profit before tax.

Cyclically challenged

There's bound to be an element of cyclicality in demand for the products Mondi deals in but I don't think the firm will suffer from the extremes that Royal Dutch Shell endures within its trading environment.

The recent collapse in the price of oil is outside Shell's control but such events show how vulnerable out-and-out cyclical firms can be to the ups and downs of supply and demand. The volatility shows in Shell's financial record:

Although cash inflow held up quite well, profits sank with the oil price. To be fair, City analysts following the firm expect a rebound in earnings of around 250% this year and 76% during 2017, but such an outcome is at the mercy of the price of oil and whatever that does.

White-knuckle volatility

Shell's share price plunged from over 2,500p in 2014 to just over 1,300p by early 2016. Since then it recovered to the current price of around 1,880p. The ride has been a bumpy one for Shell's shareholders and contrasts with a much smoother progression from just over 1,000p to today's 1,362p for those holding Mondi's shares.

At 1,880p, Shell's forward dividend yield sits at 6.8% for 2017 and earnings should cover the payout just over once -- as long as the price of oil behaves itself. The firm's recent acquisition of BG Group dangles the tantalising prospect of upside operational potential but the cyclicality in the oil and natural resources sector makes the future seem uncertain and potentially volatile. I would rather take my chances with Mondi's smooth financial trading record and its well-covered dividend.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.