Why Royal Dutch Shell may be a good long term bet

The Oil & Gas sector is still the biggest in the London market, currently representing 13.5% of the FTSE All-Share; the Mining sector has dropped to no. 3 but still represents 7% of the All-Share.  One of the easiest (ha! whoever said it was easy?) sources of relative performance over the past two years has been to be under-weight these two sectors.  I suspect that the majority of fund managers hold this position; which, in itself, might be a contrarian signal. So, the question for investors now is: has this move gone far enough?

The chart shows the performance of the FTSE All-Share (green) along with the Miners (black) and Oil & Gas (mustard) over the past four years, all being re-based to 100 in autumn 2009:

Source:   Bloomberg, FTSE International

The Miners out-performed the market until December 2010, since when they have markedly under-performed (the flotation of Glencore in May 2011 is symptomatic; their shares have not seen the flotation price since).  I think that that spike down in the summer will have marked the bottom of this particular cycle, coinciding as it did with a number of stocks reaching attractive valuations.  So, in this sector, I have been re-building holdings, with Rio Tinto and BHP Billiton being my favourites.

Oil & Gas has not shown quite such a dramatic swing in relative performance, but the under-performance since early 2012 has been marked.  Of course, the sector is dominated by Royal Dutch Shell and BP, so, in the UK market the decision on these two is crucial.  For now, I shall park BP as it remains mired in the US legal systemand uncertainty around DeepWater Horizon.  The fundamentals for Shell look attractive at these levels: consensus forecasts for this year put their shares on 9.2X earnings with a dividend yield of 5% (the dividend is more than twice covered).  Shell have also suffered from a series of disappointing results and trouble in Nigeria.

The oil price is, of course, also a major consideration when looking at the Oil & Gas stocks.  This (Brent blend) has been trading in a relatively narrow band between $100 and $120 per barrel since early 2011, ‘West Texas’ has been trading at something of a discount.  I do wonder what might happen if current more peaceful overtures from Iran continue to the extent that sanctions on their oil exports are lifted.  So, on balance, I consider that Royal Dutch Shell is good long-term value at current levels, but I am not yet planning on a move to an overweight position in the sector overall.  With sterling at current levels, those with more of an international view might also consider Chevron or Total though this latter has moved somewhat over the last few weeks.

 

 

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