Should investors buy Royal Dutch Shell plc after its profit-beating update?
This morning's uplifting Q3 update from FTSE 100 giant Royal Dutch Shell(LSE: RDSB) has done its share price no harm at all. Up 3.5% in early trading, the market clearly appreciates the latest set of figures from the £166bn cap oil giant, including a reported 18% rise in profits. In sharp contrast, shares in fellow FTSE 100 stalwart, BP are down over 3% after it reported profit had almost halved compared to the same three-month period the year before.
With shares in the former now trading near their highest levels for over a year, should investors hold on or move on?
What a comeback
Back in January, shares in Shell dipped as low as 1,277p when a barrel of Brent Crude slumped to just $28. That's far lower than the former reached even during the financial crisis. Indeed, you'd need to go all the way back to 2004 for the last time Shell's shares traded under this value.
Since then however, the situation has improved markedly. Thanks to effective cost-cutting, a reduction in capital expenditure and the oil price stabilising, Shell's share price reached the dizzy heights of 2,277p a couple of weeks ago. Those brave enough to buy the company at the time of maximum pessimism would have been handsomely rewarded.
Today's update is likely to prolong Shell's resurgence, at least in the short term. Shareholders will be pleased by the reversal in earnings, up $1.4bn compared with a loss of $6.1bn for the same quarter a year ago. News that the company's acquisition of BG has been completed ahead of time will also be warmly received, as will CEO Ben van Beurden's comments that the latest set of figures reflect the company's "strong operational and cost performance."
A word of caution
For me, however, his reflection that lower oil prices continue to represent "a significant challenge across the business" was more significant.
Make no mistake, the big draw for most investors is the juicy 7.2% yield, especially given the record low rates of return offered to savers by banks. There's also the fact that, despite multiple oil price slumps over the years, Shell hasn't cut its dividend for over 70 years.
Nevertheless, Shell's quarterly dividends are still being paid from borrowings and the stocks now trades on a forecast rolling price-to-earnings (P/E) ratio of just under 15. As odd as it may sound, that's still quite expensive based on historical valuations. Sure, earnings are forecast to recover strongly in 2017 (EPS growth of 79%) but this is dependent on what happens beyond the company's control, of course. Reducing costs and investment levels can only work for so long. While the price of black gold appears to be holding around the $50 mark for now, there's nothing to suggest that we've seen an end to the volatile period. After all, OPEC can only agree to reduce supply by so much before US drillers crank up production.
So long as your portfolio contains a bunch of geographically diversified companies operating in different industries, Shell's shares may be worth holding, particularly if the price of oil continues to drift upwards. That said, given that the risk of dividend cuts could still persist for the foreseeable future, I would caution against being too heavily concentrated in the company while the outlook is far from certain.
Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended BP and 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.