Why Royal Dutch Shell plc (ADR) (RDS.A) Presents Substantial Upside?

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We explain why Shell provides a lucrative investment bet

The recovery in oil prices along with hints of balance in supply demand fundamental for oil markets, we continue to believe that Royal Dutch Shell plc (ADR) (NYSE:RDS.A) could provide significant upside to investors. This is because currently, Brent Crude trades at around $55 per barrel, very much close to target of $60 presented by Shell where it could report significant positive cash flows. Moreover, as it is likely the case, Oil might sustain at $60 in the next year and the stock price could rally in tandem with oil prices. 

One might also expect arena of $70 per barrel in oil markets in a very bullish scenario, but $60 too presents satisfactory performance expectation from Shell. This is because the capital projects on which Shell is working on since 2014, and will continue work on until 2018, are based on very low level of operational expenditure of around $15 per barrel. 

Moreover, the company is almost halfway through its project cycle, and this would mean that its Capital Expenditure would not consume major chunk of its cash flows in the future presenting further upside. In addition to lower Capital Expenses, Shell has worked hard to trim down its operational expenses too. With the company focusing towards lower cost assets, the numbers could be expected to inch down further. 

On annual basis from 2013-2015, the company has produced free cash flows of around $12 billion, which was when oil traded at around $90 per barrel. With oil hovering around much lower, Shell expects its Free Cash Flows to be at $25 billion even at $60 per barrel, which signifies the efficiency level of the company. 

In past twelve months, Shell’s stock has traded at a multiple of 15x of its cash flow. This is at operating cash flow of around $16.9 billion. As the company expects its Free Cash Flow to be at $25 billion, the same multiple predicts much higher price for Shell even with conservative oil price estimate of $60 per barrel. Hence, we believe this could present a lucrative investment option to investors.

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