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Royal Dutch Shell Valuation

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Summary Target Company: Royal Dutch Shell Comparables: BP plc, Total S. A. , BG Group plc Recommendation: BUY The company is in good financial health since the crisis and shows potential share price appreciation in the near future due to current undervaluation of stock. Soon expanding into China, the company has one the highest five-year average free cash-flow and dividend yields and the lowest price multiples. For the value investor the stock is currently attractive, being valued between €36. 8 and €94. 39. Using the Relative Valuation method, the price is between €31 and €87.

Current price of Royal Dutch Shell – A shares on Euronext Amsterdam is €26. 2 Two closest competitors to Royal Dutch Shell are BP Plc and Total S. A. and a third company with IFRS reporting picked is a comparatively smaller oil & gas company named BG Group plc. This was done in order to contrast the other 3 extremely large firms with a smaller firm within the industry. Background Analysis Company Overviewand HistoryWebsite: www. Shell. com Type Public Limited CompanyIndustry: Oil and Gas

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Traded asLSE: RSDARSDBFounded: 1900 Euronext: RSDARSDBHeadquartered:The Hague, Netherlands NYSE:RSD. ARSD. BProducts: Petroleum, Natural gas, other Employees:90,000 Petrochemicals The company is the world’s second largest by 2011 revenues and one of the largest companies in the world by market capitalization ($215 billion). Main areas of business: Vertically Integrated in every area of the Oil & Gas industry – exploration, production, refining, distribution, marketing, petrochemicals, power generation, trading and renewable energy activities (solar, wind, biofuels, hydrogen).

With operations in 91 countries, it produced over 3million barrels a day and has over 40,000 service stations worldwide. Strategy The company aims meeting growing demand for energy worldwide at the same time being environmentally and socially responsible. The company creates wealth for shareholders through its commitment to investing in major growth projects, particularly upstream. This explains the PP&E increase by $14 billion, which was funded mostly via long-term debt financing. The upstream strategy will incorporate: Building resource base through worldwide exploration, focused acquisitions and exits from non-core portfolio positions * >80% of total capital spending * Profitable growth; price upside Downstream strategy: * Stable capital employed * Fewer refineries; upgrade chemicals assets * More concentrated marketing positions * selective growth in countries such as Brazil, China and India – have high growth potential * Margins in core countries while maintained Three layers of strategy development: i. Performance focus and continuous improvement

Improving capital efficiency by non-core asset sales will generate divestiture proceeds positively impacting the Cash Flow ii. Growth delivery Net capital investment of over $30 billion in the current year via issuance of more long-term debt and increasing the leverage ratio – done over 5 years, this will increase daily average production of barrels of crude oil by 25%, to 4million/day (2017) from current 3. 2million (2011) iii. Highest R&D as compared to any other oil & gas company in the world (over $1. 25 billion in 2011) and technologies to access proved reserves. R&D also allowed Shell to pioneer deep water oil production since the 1970s, start-up of world’s largest Gas-to-liquid (GTL) plant in2011 in Qatar and boosting oil recovery by 10% in Marmur oil field in Oman. Industry Overview Economic conditions Oil demand rose modestly by 0. 7million barrels/day in 2011 and given the expected slowdown in 2012 in the US, EU, China, India and other core and emerging markets, revenues are projected a modest 11. 4% increase in 2012, compared to a CAGR of -0. % since 2007 and CAGR of 56% since the 2009 slump. Strong economic growth in 2010 was weakened in 2011 due to several shocks were partly responsible: devastating earthquake and tsunami in Japan; political and civil unrest in some oil-producing countries in the Middle East and north Africa; major financial distress in the EU due to rising debt and high budget deficits. Many emerging economies suffered turmoil well and grew robustly in 2011, with output in China and India growing by 9% and 7% respectively. USA and the EU’s output grew by 1. 8% and 1. % respectively; not sufficiently rapid to bring down high unemployment rates. With concerns about a global economic slowdown for 2012, analysts expect recession to set in the EU and further slow economic growth in the USA. Economic activity although more robust in emerging economies their performance still remains closely linked to the developed world. Most projections assume that policymakers in developed economies keep their monetary and fiscal policy commitments and manage to control the financial turmoil, allowing conditions to stabilize. Competition

Intense competition exists for access to upstream resources and to new downstream markets. But we believe our technology, project-delivery capability and operational excellence will remain key differentiators for our businesses. Other 5 Supermajor companies BP plc, Chevron Corp, ExxonMobile, Total S. A. and ConoPhillips all heavily invest in access to both upstream and downstream resources and markets. Recent History and News Friday, Oct 26, 2012 Announces share buyback as part of Treasury Repurchase program to increase the EPS and hence consequently stock price.

The purpose of the share buy-back program is to offset dilution created by the issuance of shares for the Company’s Scrip Dividend Program. 2009–2010 Shell donated over $300,000 to the then governor of Pennsylvania, Tom Corbett, which was possible payoff for no severance tax and environmental policies’ repeal; created to protect the environment from natural gas drilling. 2009 In 2009, Shell agreed to pay $15. 5m in a legal settlement relating to Nigeria back in the mid-90s, for human rights violations. August 2008

British Advertising Standards Authority (ASA) ruled: The company misled public in advertisements by claiming a $10 billion oil sands project in Alberta, Canada to be a sustainable energy source. 2007 Sakhalin-II project in Russia and the controversial Corrib Gas Field development in Ireland has had problems. In 2007 Friends of the Earth alleged that $20 billion in damages was caused to local communities and the wider environment by Shell’s oil activities 2004-2007 Company overstated oil reserves leading to investors losing confidence in the group, a fine of  ? 7million by FSA and payment of $450million to European and Non-American shareholders. 2. Valuation using Dividend Discount Model Dividend history The company has paid quarterly dividends ever since the 2005 Q2 2:1 stock splits and we maintain that this pattern will continue in the years to come. | 2007| 2008| 2009| 2010| 2011| Net Income| 31,331 | 26,277 | 12,518 | 20,127 | 30,918 | Dividends paid| 9,204 | 9,841 | 10,717 | 9,979 | 7,315 | Dividends per share| 1. 47 | 1. 60 | 1. 75 | 1. 3 | 1. 18 |  | | | | |  | | | | | |  | Earnings per share (EPS)| | | |  | Basic EPS| 5. 00 | 4. 27 | 2. 04 | 3. 28 | 4. 98 | Basic Shares outstanding| 6,263. 8 | 6,159. 1 | 6,124. 9 | 6,132. 6 | 6,212. 5 | The management states that their new policy is to grow USD dividend with underlying earnings and Cash Flow of Shell. But his remains unlikely given that this was not followed in 2010 and 2011- by 60% and 51%, and dividends decreased by -7% and -28% respectively for the 2 years.

We estimate that a 2007-2011 CAGR (geometric mean) of Div. Payouts of 35% is appropriate for projecting future dividend payments. 2009 outlier is rejected in our calculations since because of the recession, to retain investor confidence in the company the management decided to have an 85% dividend payout for that year. We believe this is unsustainable and hence calculated the CAGR over 2007-2008 and 2010-2011 plowback ratio (65%) and subsequently found dividend payout ratio (35%) Dividends declared are in US dollars and the Euro and GBP equivalents amounts are announce at a later in the year.

Dividends declared on Class A shares are paid in Euros (default); holders of Class A shares are able to elect to receive dividends in GBP. The Scrip dividend program from September 2010 onward gives shareholders the option to increase their shareholding by choosing to receive dividends declared in the form of new shares instead of cash. The dividends can also be reinvested via cash or shares, using this program. Cash dividends on Class-A shares are subject to 15% tax rate in Netherlands and a non-payable dividend. tax credit in the UK. Forward-looking Assumptions

The CAGR of last 5year Net Income growth is at -0. 1% due to the 2009 outlier event. And 2009-2011 CAGR is at 56%. It is safe to assume that the company will grow at least 11. 4% for the next 5years with at least a 2% perpetual growth. 11. 4% is the average 5year growth rate. CAGR of the plowback ratio and dividend payout ratio are also calculated based on excluding the 2009 outlier event and a decent number 65% (retention) and 35% (div payout) is arrived at. Dividends paid out are a percentage of Net Income, which is estimated to grow at afore mentioned rate. Choice of model

Given that Shell pays out dividend as percentage of their Net Income, the method of dividend payouts calculation is explained below under Sensitivity Analysis. Given that the company has paid quarterly dividends ever since the 2005 Q2 2:1 stock splits, given the high oil prices and Net Income 2009-2011 CARG of 56%, it is safe to estimate that this pattern of quarterly dividend payouts will continue in the years to come. The number of stages in the Dividend Discount Model (DDM) depends on the time to recovery in the global economy and the competitive environment.

We have used a 3-stage model: 1st stage: With Net Income projected to grow at 11. 4% and dividend payout maintained at 35% of NI, the dividend growth for 1st year is 64. 9%. 2nd stage: Dividend grows with Net Income at 11. 4% – conservative estimate and co-incidentally, as projected by management 3rd stage: The terminal growth rate is assumed to be around 2%, faster than the growth of the British economy since the firm has majority of operating revenues from overseas. This 2% is close to IMF estimates of developed countries Although the 1st stage dividend growth seems to be astronomical, it will be adjusted in the following years.

We estimate that if dividend doesn’t grow at 64. 9% in 2012, then the leftover growth from this year will be realized in 2013 onward which will have a higher dividend growth rate than 11. 4%; justifying the growth (2%) and cost to equity assumptions (6. 3%) taken. Sensitivity Analysis With Cost of equity at 6. 3%, Terminal growth rate at 2% and Dividends paid out at 35% of Net Income which grows at 11. 4% per year, the present value of the company stock is €52. 28. The company is currently undervalued at €26. 20 per share (as of Friday, Oct 26, 2012).

Even with a 1% terminal growth assumption and 7. 3% cost of equity, the company’s share price should be around €36. 78. There is room for at least (36. 78/26. 20)-1 = 40. 38% share price appreciation in the near future, given the present growth rates. This expected 40. 38% holding period return could be in the form of more shares or dividends, or in the share price appreciation itself. | Change in growth (g)| by| 1. 0%| Sensitivity analysis:|  |  |  |  | | 52. 28| 1. 0%| 2. 0%| 3. 0%| Change in ke| 5. 3%| 56. 44| 69. 67| 94. 39| By| 6. 3%| 44. 71| 52. 28| 64. 43| 1. 0%| 7. 3%| 36. 8| 41. 52| 48. 48| In the DDM sheet in excel file, by manually changing growth rates and cost of equity in cells B28, F23, N2 (or C27) and M16 – a broader range of values for estimated prices (D26:G28) can be achieved. 3. Relative Valuation using Multiples method Competitors: BP plc, Total S. A. , BG Group plc Multiples Price Earning: Defined as the ratio of price of company compared with Earnings per share. Higher P/E relative to industry and competitor average suggests overvalued stock. Low P/E suggests undervaluation. P/E ratio = Market Value per Share/Earnings per Share (EPS).

Price to Book Value: Book Value is defined as the total value of the company’s assets that shareholders would theoretically receive if a company were liquidated. P/B ratio =Share price(Total Assets – Intangible assets – total liabilities)/no of shares outstanding Investors should be weary not to get into the Book Value trap, where the company’s assets are undervalued due to market conditions or Oil price-demand discrepancies. After many years, global oil supply is now forecast to exceed demand over the next few years. No imminent oil price increase shock would mean Oil stocks underperform for a sustained period of time.

Price-to-Sales: P/S ratio = Price of share/Total Net Revenues A very inefficient metric, largely due to the fact that it does nothing to predict Net Income – a company could have positive sales and yet report negative Net Income and Cash Flows from operations. Price-to-EBIT: P/EBIT = Price per share/Operating profit per share This metric is useful in measuring when given that interest expense and taxes remain fairly constant (new debt is taken on in proportion to old debt, interest rate remaining constant). Price-to-EBITDA: P/EBITDA =Price per share/Gross profit

The multiple calculates P/EBIT before non-cash items D&A are taken into consideration, since these can be manipulated to boost or reduce earnings for the current period, depending on management strategy to show earnings at a future date, when it will be required due to fall in revenues. Ratio Analysis Organizing Consolidated Financial Information Annual reports for Royal Dutch Shell downloaded from website and data entered in excel sheet Consolidated income statement, balance sheet and cash flow statements: organized in excel sheet under Consolidated Statements worksheet.

All 3 are on same sheet to prevent too many worksheets in the same workbook – as it is the Ratio and Competitor analysis will take up almost 10more sheets Company’s core operations: Upstream business: Oil & gas exploration, transportation of gas, managing US-based wind business. Downstream segment represent the majority of revenues generated: manufacturing, marketing and distribution of oil products and chemicals, bio-fuel production. Revenues and Expense recognition:

Revenue recognized at fair value of consideration received (receivable) from sales of oil, natural gas, chemicals and all other products, after deducting taxes (duties and levies), after the transfer of risks-rewards to the other party. There are many types of expenses associated with the company’s operations. For example, Pension expense represents increase in the actuarial PV (present value) of obligation for pension benefits based on service of employee during the entire year.

Another type of expense that is actually capitalized is the Finance lease payments which is divided between interest expense and repayments of debt. Consolidation methods used Assets and liabilities of non-dollar items are translated to dollars at year-end exchange rates, while their income statement, cash flows and other comprehensive income are translated at quarterly average rates. Consolidated Statement of Income presentation: Purchases reflect all costs related to inventory acquisition and include supplies used for conversion into finished (or intermediate) products.

Policies, methods and assumptions are used to account for non-current assets PP&E held under finance leases and operated by Shell as contractors. Recognized in Balance Sheet as cost, when it is probable that they will generate future economic benefits; PP&E and intangible assets carried at Cost less Accumulated depreciation, depletion, amortization and impairment (if any). Policies, methods and assumptions are used to account for financial instruments Recognized as available for sale, carried at Fair Value (except when it can’t be measured reliably – then they are carried at cost less impairment).

Interest expense on debt is recognized using the effective interest method and dividends (on held equities) recognized when receivable. Derivative contracts recognized at fair value. Policies, methods and assumptions are used to account for provisions Recognized a t Balance Sheet date with a best estimate, using risk-adjusted future cash flows; non-current amounts disclosed using risk-free rates. Carrying amount regularly changed and adjusted for new facts, law or technology. Provisions for decommissioning costs are measured on basis of current requirements, technology and price levels.

Common-size Analysis Under worksheets named PL Common Size and BS Common Size. Note: The numbers in 2009 are skewed due to the global economic crisis; Sales were down for 2008-2009 hence other items appear as a larger percentage-share of Total Revenues Financial performance: The company’s performance on the whole shows that even though Revenues are increasing after the 2009 crisis and are higher than their 2008-peak, the Cost of Goods Sold is taking a toll on the Profit & Net Income margins. Some of the main metrics are described below 1. PL Common Size: Total Revenue and Other Income is considered as the base (100%) * Revenue from Operations has remained steady around 97% of the base * Operating Expenses (Cost of Sales): Increased from 82. 5% (2007) to 85. 5% (2011) * Recurring operating Income (EBITDA) declined from 17. 5% (2007) to 14. 5% (2011) Operating profit (EBIT) declined along with pre-tax Income and Net Income. Lowest income was posted in 2009 due to the global economic slowdown (crisis), but these numbers have picked up (on upswing) since then; still not near their 2007 peak * Finance costs are represented by Interest Expense which have remained steady around 0. % of Total Revenues * Share of profit of associates and net profit (group share): Income from non-core operations (eg. Share of profit of Equity accounted investments or Interest & other income from affiliates, or Income from Minority interest) have remained fairly steady and represent less than 4% of Total Revenues. This is a good sign, given the company is focused on generating cash flows mainly from core operations * Absolute value of dividends paid remained steady around the $9b-$10b, decreasing to $6. 8b only in 2011 as percentage of Net Income

Under PL % change, BS % change, CF % change: Again, note that 2009 number are a special circumstance – global economic crisis – caused slowdown and Net Income actually decreased from 2008 to 2009. Although the performance has picked up since then: * Operating expenses: Cost of goods sold (total of purchases, production & manufacturing, R&D, exploration, SG&A, etc) is rising every year – both in absolute terms and as percentage of Total Revenue – decreasing the profit margin * Operating income recurring: Revenues from core operations rising every year (again, 2009 exception).

This seems sustainable, given the size of firm’s operations, its line of business, and continuously rising world oil demand and oil prices(over the past few years) with no signs of a slowdown * Finance costs: Apart from 2009, Interest Expense grew by a big margin every year * Share of profit of associates and net profit (group share): Income from non-core operations (eg. Share of profit of Equity accounted investments or Interest & other income from affiliates, or Income from Minority interest) has grown post-2009

Arithmetic average of last 4-year/5-year growth rates and Compounded Annual growth rates calculated * Operating expenses: Apart from 2009, operating expenses are way above their arithmetic average and CAGR * Operating income recurring: CAGR of 7. 22%; apart form 2009 Revenues grow much faster than their 5-year arithmetic average and CARG * Finance costs: Same case here.

Excluding 2009, the interest expense (cost to service debt) rises much higher than CARG and computer 5-years growth rate * Share of profit of associates and net profit (group share): post-2009, profits are on an upswing although not up to par with its 2008 pre-crisis peak; NI has a CAGR of -0. 59% and Income from Minority interest has a CAGR of -18. 15% Point of concern: CAGR for Total Revenues and other Income is 6. 99% and for Revenues (form core operations) is 7. 22%.

Operating Expenses (COGS) has a compounded annual growth rate higher than the revenue increase, 7. 96%. This will be unsustainable in the long-run, negatively impacting Profit Margin, Net Income and Free Cash Flow tot eh firm. But with the current growth rate if replicated in FY2012, the CAGR for Net Income (both, group and associates) will be positive, surpassing its pre-crisis peak and moving on to new highs. BS Common Size: Financial position: The company seems to be in an expansionary phase, increasing the ratio of Non-current assets to Current assets.

Given that this is an Oil & Gas company, the net investment in PP&E will be very high and it is increasing every year, as percentage of Total Assets. It seems that the company is using long-term debt to finance most of its expansion of operations; keeping deferred tax, other provisions, taxes and short-term debt constant we can affirm that the company needs little to no short-term financing (also confirmed by Net Days of Financing required, under Financial Ratios worksheet) – it is almost self sufficient in generating cash flow from present operations, servicing all its immediate needs.

Only in 2011 is it evident that the company has marginally decreased dividend payments, increasing Retained Earnings – management states this would be reinvested by its concerned subsidiaries. * PP&E (fixed assets): For a company in this line of business PP&E makes up a very high percentage of Total Assets * Inventories: decreased from 11. 4% (2007) of Total Assets to 8. % (2011) – this fall in Inventory as percentage of Total Assets is one of the reasons for Revenues CAGR being smaller than COGS CAGR * Receivables: Falling Accounts Receivables denote more cash on hand (higher Cash flows for current period) and that the company is aggressively ensuring payment earlier from its clients. From 2007-2011, receivables only rose by CAGR of 1. 38% * Total Assets picked as the base (100%) – increased constantly for last 5years. Total Non-currents assets increased as percentage of Total Assets from 57% (2007) to 65% (2011).

Total Current assets declined from a 43% share to 35%, as percentage of Total Assets * Total Non-current Assets: Make up majority of Total Assets. 10% CAGR increase * Cash & Cash Equivalents remained steady except for 2008, when the company’s NI fell by more than 50% and dividend payouts actually increased to its highest in past 5-years to $10. 7b – reinforcing investor confidence in long-term operations of firm * Total Liabilities represent a steady over 50-54% of firm’s Liabilities and Equity. Total Equities represent a steady 46%-49% this total number, balancing the ccounting equation ASSETS = LIABILITIES + EQUITY * Long-term debt rises and almost doubles as percentage of Tot. Liabilities & Equity. Obligations and Provisions remain steady throughout * Treasury Shares constantly repurchased every year to maintain EPS from a number of management activities, like expansion and acquisition. Also, stocks, warrants, preferred equity are issued every year in form of compensation for employees. Treasury stock repurchases effectively manages EPS by maintaining a steady No. f Shares Outstanding * Non-current Financial assets and Investment in associates: Composed of Investments in Equity, other financial investments and deferred taxes – CAGR of 7%, 12% and 10% respectively * Current & non-current borrowings: Long-term debt increases at CAGR of 25% and Non-current liabilities at 10%; short term debt has CAGR of only 4% and current liabilities of only 2% – company is financing expansion via long-term debt, as stated earlier * Provisions: Non-current provisions with CAGR of 3. 4% – increasing post 2008. Current provisions with 2. 7% CAGR – although, decreasing since 2009

Comments on Company’s overall trend in revenue: how has evolved sales growth compared to growth in net profit (group share): Growth in revenue in absolute terms from 2007 to 2001, barring 2009 recession – CAGR of 6. 99%; but Net Income (profit) is falling as share of Total Revenues. This is due to the fact that Cost of Goods Sold rises – even though SG&A is cut in order to maintain profit margins, R&D, exploration, production & manufacturing and Purchases from suppliers make up the rest of COGS – and they increase rapidly, especially purchases from suppliers growing at CAGR of 9% and given Total Revenue CAGR of 6. 9%, net income has CAGR of -0. 59% as a result of this. Comments on Company’s ability to keep operating expenses under control (compare in particular growth in operating expenses to sales growth, operating income growth and net profit): As state above, the company has been unable to decrease its expenses related to Purchases from suppliers and production & manufacturing expenses. Operating expenses (COGS) grows by 7. 96% CAGR versus Operating Sales growth of 7. 22% CAGR and Total Sales growth of 6. 99% CAGR.

This is cutting into profit margins and Operating Income grows by a mere 2. 5%. After interest expenses and taxes, Net Income shrinks by 0. 33% CAGR for the entire group. Comment on Company’s overall evolution of the proportion of non-current assets vs. current assets and the proportion of non-current liabilities vs. current liabilities. Is the company being conservative or aggressive in the way it finances its asset base? Company’s core activities require heavy investment in PP&E, and the company has been in a constant expansion phase – with PP&E investments rising at 10. % CAGR and Non-current assets rising by 10% CARG. Current assets rise by less than 1% CAGR. Non-current asset CAGR of 7. 9% and current asset CAGR of . 075% over 5years for the company. Non-current liabilities rise much faster (10% CARG) than current liabilities (2% CAGR) – company financing its expensive PP&E purchases for expansionary purposes via long-term debt. Non-current liabilities make up about 41% of Total liabilities – CAGR of 7. 83% whereas Current liabilities make up about 59% of total liabilities, with CAGR of only 1. %. This reconfirms previous stand that company is financing PP&E purchase (expansion) via long-term debt (Non-current liability). The company has enough Cash and Cash Equivalents to service its debt for few years even if it makes net loss. So debt financing, without diluting stake of shareholders and without diluting EPS and hence without negatively affecting stock price, the company is using Debt (leverage) to expand into new projects with a higher rate of return than cost of debt currently.

This makes more sense to do, since cost of equity is higher. Ratio Analysis: Worksheet named Financial Ratios Asset Utilization (Efficiency) Ratios calculated: Accounts Receivables turnover, Inventory turnover, Accounts Payables turnover, Asset turnover, Days sales outstanding, Days inventory outstanding, Days payable outstanding, Net days financing required Increasing Accounts Receivables turnover implies company is operating on Cash asis and extension of credit and collection of accounts receivables is efficiently managed. Decreasing Inventory turnover ratio shows it is taking fewer days to sell inventory at hand – good management Increasing Accounts Payable turnover imply the company is taking shorter to pay of its purchases from suppliers – good sign, since company has more cash at hand (liquidity) to pay of its short-term debt quickly. Decreasing Asset turnover implies slightly worsening conditions.

The company is not making efficient use of its assets to generate substantial revenue Decreasing Days Sales Outstanding imply company is collecting revenue quicker – efficient management Increasing Days Inventory Outstanding implies it takes longer for the company to turn its inventory into sales slightly worsening condition Decreasing Days of Payables Outstanding implies company is paying off its creditors earlier – good sign, since it must have higher cash at hand (liquidity) in order to achieve this Rising Net Days Financing required implies slight decrease in liquidity and short-term cash instruments; so the company may have to finance its purchases for an average of 5. 7days (2011) as compared to 3. 5days (2007) Liquidity ratios: Current ratio and Quick ratio – Steady Current ratio (CR) overall. But rising CR from its 2008-bottom indicates improving ability of company to pay its short-term obligations. From 2007 to 2008, the firm lost some ability to pay off its short-term obligations, falling from 1. 22x to 1. 10x – Steady Quick Ratio indicates that company maintains ratio of liquid current assets of 0. 9x liabilities.

So if it had to pay off all its liabilities together, the company could do so for 90% of its liabilities – immediately – good shape, the company is in Gearing ratios: Gearing ratio, Shareholder’s ratio and Interest cover – Gearing ratio = (Total Liabilities – Current liabilities)/Capital Employed. Fairly steady and slight increasing number indicates that long-term liabilities are increasing slightly as a proportion of Capital employed (total assets less current liabilities). In line with statement that company is funding expansion with long-term debt – Steady Shareholder’s ratio indicates the ratio of Shareholder’s funds (ordinary share capital + treasury shares + retained earnings) to Capital employed. The ratios over past 5 years show steady involvement of shareholders and long-term liability financing. For $1. 66 financing, $1 is in debt and $0. 6 is in equity – Falling Interest coverage ratio indicated that the debt expense burden on company is decreasing – good sign. Only time it increased was from 2010-2011, due to heavy acquisition of assets for expansion. Profitability Ratios: ROA, ROE, Gross Margin, Profit Margin, Financial Leverage (Equity Multipliers) – Rising ROA since 2009 implied increasing profitability of company relative to size of its total assets – management has used assets efficiently to generate earnings and 9. 3% ROA of 2011 is almost at par with 2007 ROA of 9. 5%. For every $1 invested in 2011, $0. 09 has been generated for the business, compare to $0. 04 generated in 2009 Rising ROE since 2009 indicates rising profitability of company with shareholder’s invested money – this is a good sign, just like rising ROA. After the 2009 fall in these metrics, the company has done well to match up to its pre-crisis ROE highs: 21% in 2008 and 19. 5% in 2011. For every $1 invested in 2011, $0. 19 has been generated for the business, compare to $0. 21 generated in 2009 – Net Profit margin has a net decline from 2007 (8. 5%) to 2011 (6. 4%). But the good news is rising profit margins for last 3 years 4. 4% (2009), 5. 6% (2010) and 6. 4% (2011) – this also results from the COGS rising faster than growth in net revenues. For every $1 of Sales generated, $0. 6 is generated as retained as earnings after expenses (COGS, salaries, etc), taxes, interest and $0. 14 is generated as EBITDA Financial Leverage (Equity Multiplier): The assets of the firm are financed by both equity and liabilities. For every $1 in Equity, the company has (is represented by) $2. 08 (2011) and $2. 17 (2007) worth of assets – measure of indebtedness – used in DuPont Analysis. The measure remains fairly steady over the last 5-years. And it has decreased slightly leading up to 2011 since the company (on expansion phase) is funding its PP&E through long-term debt, as visible on the Balance Sheet and Common size statement calculations.

Investment ratios: P/E, P/S, P/B, Dividend yield, and FCF yield calculated and presented in excel sheet Comments on investment ratios: the firm has created value for its shareholders since 2007 and on the firm’s ability to generate positive cash flows: A firm can create value for shareholders in two ways: i. either by paying out dividends when Internal Rate of return is lower than Expected Market return ii. Stock price appreciation In the case of Royal Dutch Shell, the company’s share price rose from 1785 (2007 beginning) to 2380 (end of 2011). And dividend yield maintained fairly constant except in 2001 when it declines by 0. 2% – hence the company has created shareholder value. Another method of calculating Price = (P/E) * Price of stock – rose from 423. (2007) to 479 (2011), even though it has been falling since 2009, overall it is up from 2007. PB ratio has been falling and the company seems to be undervalued – being a conglomerate with international operations, and thus with huge amounts of international assets the company can create book value through growth in overseas and foreign assets – large component making up the book value is the PP&E (Oil rigs) and other transport machinery. It is also seen that the company is expanding PP&E through long-term debt, increasing its Book Value rapidly over the past 2-3years. Price not rising at same rate, thus P/B ratio is declining – company undervalued. Falling P/S ratio indicates that sales are rising faster than the company’s stock price – reinstates our expectation (thus far) that the stock is probably undervalued. The P/S ratios values stock relative to company’s past performance. – Rising FCF Yield (back to 2007 peak) indicates the company’s share price is becoming more attractive. – The Debt Service Coverage ratio (DSCR1) is calculated as Net Income/(Total Interest and Principal expense on debt Service). Decreasing from 7. 92 (2007) to 4. 94 (2011), the firm still retains ability to cover its debt payments. – And just to reconfirm the above stance, it is recalculated as DSCR2 = Cash and Cash Equivalents/(Total Interest and Principal expense on debt Service), decreasing form 2. 4 (2007) to 1. 79 (2011), the firm could cover its debt payments 1. 9x over with just its Cash & Cash Equivalents accumulated up to December 31, 2011 – The firm has maintained a fairly steady dividend policy (except 0. 2% decrease in 2011), and is constantly generating Net Cash flows (except 2009 global recession) and has a positive Cash balance. With expansionary projects lined up via long-term debt financing and the company’s full ability to service its Debt, the dividend policy seems sustainable for the futures years to come. ————————————————- Note: ————————————————- Diluted EPS is used to calculate the Price-Earnings ratios in order to have a conservative approach.

As we know, diluted EPS takes into account the options, warrants, convertible preferred shares, etc. Although it is unlikely that all these are converted into common stock every year (and together), taking the diluted EPS estimates P/E ratio to be lower, which is good if projecting price form a conservative view point. If price actually ends up higher than the projected (conservative) price, the investors are more pleased. Overstating of Price per share is also avoided, using this method. 3. VALUE INVESTING Criteria Value Investors are interested in company when the shares are underpriced fundamentally. Following are the criteria require to be met: I.

Public companies trading at discounts to their tangible book values II. Low P/E and P/B multiples, low P/Cash Flow ratios, III. High dividend and FCF yields The idea is to buy stocks at less than their intrinsic value (discounted value of all future cash flows). These stocks generally (not always) outperform growth stocks on overall market. Note for potential investors Royal Dutch Shell is a classic value investment case. As seen from graphs above, the company has the highest Dividend (except 2011) and FCF yields (both yearly and 5 year average). It has the lowest P/E, P/B, P/S and one of the lowest P/EBIT and P/EBITDA multiples in the industry.

The company has the highest profit margin, return on assets, return on equity and the lowest Debt-to-Equity (Leverage) ratio, which means there is currently less interest expense as percentage of net income and room for immediate expansion via long-term debt financing that the company started taking advantage of, 2010 onward. The company is also characterized by the highest inventory turnover, CFO to CapEx and CFO to liabilities, one of the highest quick (liquidity) ratios and the lowest net days of financing required meaning it generates more cash as percentage of its operations than the industry average. The maximum price an investor should be willing to pay (with 6. 3% ke and 2% growth) is €30. 9 – the lower range of Equity Value per share in relative valuation. Intrinsic value is €52. 28, expected holding period return could be around (€ 52. 28/€ 30. 9)-1 = 69%, with an at least 5year holding period. Industry Analysis

Note: for some of these ratios, BG Group’s values are not graphed since 3 large company’s ratios were enough to give a proper picture of the Supermajor oil producers. Due to time constraint, BG Group was left out, but is more than compensated with the detailed explanations below. Two closest competitors to Royal Dutch Shell are BP Plc and Total S. A. and a third company with IFRS reporting picked is a comparatively smaller oil & gas company named BG Group plc. This was done in order to contrast the other 3 extremely large firms with a smaller firm within the industry. Shell has been more efficient than peers in managing its working capital and its long-term assets: Target Company has: i. ore liquid assets that BP Plc and less than Total SA, around industry average ii. lower Long-term debt to equity leverage than both competitors and industry average iii. higher ratios of CFO to CapEx and CFO to Liabilities, than industry average iv. lower accounts receivables turnover than industry average v. higher inventory turnover than both competitor firms, and industry average vi. higher accounts payables turnover than industry, but lower than Total SA vii. higher Days sales outstanding, lower Days inventory outstanding and lower days payables outstanding lead to the Target company requiring the lowest number of days of financing by any of the 3 companies viii. ighest ROA and ROE, highest Profit Margin (ties with Total SA), lowest financial leverage, highest Book-value per share and FCF per share and highest dividend yield up to 2010 These are the reason we can use to justify that YES, the company has been more efficient than its peers in managing Working Capital and Long-term assets. Shell’s ability to meet short-term obligations evolved since 2007 compared to peers: ix. For Target Company, the Current Ratio showed a slight decrease to lower than industry average in the past 5years and BP’s CR showed a minor increase, while Total SA remained steady (highest), while Quick Ratio remained steady around the industry average. x.

CFO to liabilities decreased for all 3 companies, but Target company’s remains higher than industry average xi. CFO to CapEx remained steady for Target company, while the metric decreased for peer companies xii. Interest coverage also decreased for all 3 companies, but Target company’s remains higher than industry average xiii. Net days of Financing required remains lowest by a huge margin xiv. DSCR (Debt Service Coverage Ratio) decreased and remains lowest among the 3 companies, and hence industry average xv. FCF/share also increased for Target company and remains highest amongst the comparables Shell’s profitability to peers:

In the Upstream business, all 3 companies focus on exploration for new liquids and natural gas reserves and on developing know-how and major new projects where our technology to add value to shareholders. It is the implementation of this strategy that has set the Target Company apart from its 2 competitors apart in FY2012, when most analysts predict slowing growth in the US and EU, and also in emerging economies like China and India. Rise in demand for oil products is deemed to be modest this year and revenues (expected to grow) may not rise as much as did since the 2009-bottom. In downstream business, the companies emphasize on sustained cash generation through increased profit margins (high revenues and low costs).

Target Company has been less successful in maintaining Total COGS within the range required, and hence is experiencing falling profit margins since 2009. Shell’s leverage evolved since 2007 compared to peers: xvi. Long-term debt to equity has almost doubled in the past 5years (9. 8% to 18%) for Target company, but is still far lower than the industry average (32%) and lower than both competitors – BP plc doubled its Long term debt-to-Equity ratios as well but Total SA kept it constant over the same time period xvii. Financial leverage (Equity multiplier) has remained steady over the past 5years, and lower than both competitors and hence industry average xviii.

Gearing ratio has remained steady for all 3 competitors and remains lowest for the Target company Shell’s dividend policy as compared with peers’: Target company has a declining dividend yield since 2008 but is still higher than industry average – the company started expanding rapidly in the past two years using part of retained earnings and part of long-term debt issuance. The 2 competitor firms’ dividend policy has remained fairly stable over the past 4 years. 1year Share price performance: Above is graph representing share prices of Shell, BP and Total S. A. since October 2011 end. This portion is zoomed in to present recent (1year) stock price performance. FINAL RECOMMENDATION: BUY

Target company (RSDA) has show less volatility and more resilience to down trends. For a majority of the time, RSDA’s share price has fallen less as compared to its competitors, and simultaneously showed more upside potential during bull markets. It is almost as if the Beta of target-company as compared to competitors is low during bear markets, and high during bull markets. Clearly the smaller market-cap BG Group has outperformed its large peers, but Shell has outperformed all the large comparable firms. BP’s share price performance has been the poorest in the given time frame and Total SA has outperformed Royal Dutch Shell in the last 3 months. In retrospect, a safer stock to invest in would have been Total S. A. if capital preservation is what the investor was looking at over the last 5years. If investor was looking for capital appreciation, Royal Dutch Shell would have been the best pick out of the 4 companies, since 2009 lows. 27 Due to Oil price-demand discrepancies the crude oil prices fluctuate and higher oil prices lead to higher earnings for the companies and consequently higher stock prices. Sustained or falling oil prices deflate industry incomes and share prices. Given that the, global oil supply is forecasted to be in excess of demand over the following years, no imminent oil price increase shock would mean Oil stocks underperform for a sustained period of time.

Nevertheless, Shell is still undervalued compared to its competitors in other ratios like the P/E, P/EBIT, P/EBITDA. The company also has the highest 5years average Dividend and FCF yields of the competitors considered. Dividend yield (4. 17%) is second only behind Total S. A. (6. 05%) only for 2011. In 2012, Shell is maintained to reclaim the top spot once again, following 2 years of intense investment in expanding PP&E and correcting for 8. 79% and 8. 23% dividend yields in 2008-2009 and 85% dividend payout ratio in 2009. Graphs below show undervaluation of Shell with respect to competitors and its higher attractiveness as a stock from higher FCF and Dividend yields:

Overall Shell’s financial performance compared to its peers since 2007: As mentioned in this paper earlier, the stock of Royal Dutch shell is an outperformer since 2009’s lowest point and even currently is undervalued due to reasons discussed earlier: falling P/E, P/B and P/S ratios, rising FCF yield since 2009 and highest dividend yield of the lot (expect for in 2011). The Target Company has been managed fairly well (especially as compared to BP plc, and seems to have very promising returns in the near future with sufficient Cash flows to cover its expansion policy via long-term debt financing, high oil prices and rising world demand for the product.

Net days of financing required is also the lowest for Target Company, and with accounts payable with CARG of 2% – slightly higher than Accounts receivable (1. 7%), the company seems to be increasing liquidity effectively for the short-term, unlike its competitors. Investment Ratios| 2007| 2008| 2009| 2010| 2011| P/E|  |  |  |  |  | Royal Dutch Shell Plc| 5. 77x| 4. 27x| 10. 41x| 7. 63x| 5. 68x| Industry average| 9. 52x| 8. 46x| 9. 02x| 9. 09x| 7. 47x| |  |  |  |  |  | P/BV|  |  |  |  |  | Royal Dutch Shell Plc| 1. 49x| 0. 90x| 0. 98x| 1. 06x| 1. 05x| Industry average| 3. 60x| 2. 67x| 2. 77x| 2. 21x| 1. 99x| |  |  |  |  |  | P/S|  |  |  |  |  | Royal Dutch Shell Plc| 0. 49x| 0. 4x| 0. 46x| 0. 41x| 0. 36x| Industry average| 1. 75x| 1. 75x| 1. 89x| 1. 45x| 1. 44x| |  |  |  |  |  | P/EBIT|  |  |  |  |  | Royal Dutch Shell Plc| 3. 5x| 2. 2x| 6. 0x| 4. 2x| 3. 1x| Industry average| 4. 6x| 3. 9x| 4. 5x| 4. 0x| 4. 9x| |  |  |  |  |  | P/EBITDA|  |  |  |  |  | Royal Dutch Shell Plc| 2. 8x| 1. 7x| 3. 6x| 3. 0x| 2. 5x| Industry average| 3. 4x| 3. 2x| 3. 6x| 3. 0x| 3. 3x| |  |  |  |  |  | FCF yield|  |  |  |  |  | Royal Dutch Shell Plc| 5. 49%| 7. 91%| -3. 86%| 0. 27%| 5. 97%| Industry average| 4. 74%| 0. 00%| 0. 22%| -1. 94%| -0. 33%|  |  |  |  |  |  | Dividend yield|  |  |  |  |  | Royal Dutch Shell Plc| 5. 11%| 8. 79%| 8. 3%| 6. 51%| 4. 17%| Industry average| 2. 26%| 3. 04%| 2. 77%| 2. 77%| 2. 92%| With over $100billion in investment committed to over next 4years, targeting to increase output by over 15% to 3. 7m barrels of oil/day from the current 4m barrels/day within 2 years, disposal program of non-core operations (refining and marketing assets) and getting a leaner, more cost effective structure and with future expansion lined up in China, the company is set to provide capital appreciation for shareholders. The company is a BUY for a long-term investment horizon. Bilbiography: DATA COLLECTED: – Bloomberg Terminal (market data) Industry and company reports: Annual Reports Form 20F Royal Dutch Shell Investor’s website: http://www. shell. com/home/content/investor/financial_information/annual_reports_and_publications – Annual Reports Form 20F BP plc’s Investor’s website: http://www. bp. com/sectionbodycopy. do? categoryId=9039423&contentId=7072266 – Annual Reports Form 20F Total S. A. Investor’s website: http://www. total. com/en/investors/results/2012/second-quarter-2012-results-202218. html – Shell Retail presence [http://reports. shell. com/investors-handbook/2011/downstream/retail. html] – Shell Website [http://www. shell. com/home/content/investor/financial_information/scrip_issuance_and_buybacks/] – Shell website [http://www. shell. om/home/content/investor/dividend_information/dividend_policy/] – Shell website [http://www. shell. com/home/content/investor/dividend_information/drip/] METHODOLOGY: – Bodie, Kane, Marcus. Essentials of Investment (8th edition) [ISBN: 9780077134501] – Barry Elliott, Jamie Elliott. Financial Accounting and Reporting [ISBN? 10: 0273760882] PRESS RELEASE and NEWS Highlights: – “Market Cap Rankings”. Ycharts. Zacks Investment Research. April 8, 2012. Retrieved April 9, 2012. [http://ycharts. com/rankings/market_cap] – ConocoPhillips: The Making Of An Oil Major”. Business Week. 12 December 2005. Retrieved 2006-09-29. [http://www. businessweek. com/stories/2005-12-11/conocophillips-the-making-of-an-oil-major] Analysis: Shell open to off-shore drilling, E&P News, July 10, 2009 [http://www. rigzone. com/news/article. asp? a_id=78139] – Tom Corbett, Republican”. Marcellusmoney. org. Retrieved 17 May 2012 [http://www. marcellusmoney. org/candidate/corbett-tom? order=title_1&sort=asc] – Corbett repeals policy on gas drilling in parks”. Post-gazette. com. 29 March 2012. Retrieved 17 May 2012. [ http://www. post-gazette. com/stories/local/region/corbett-repeals-policy-on-gas-drilling-in-parks-286166/] – Ed Pilkington in New York. “Shell pays out $15. 5m over Saro-Wiwa killing”. The Guardian. Retrieved 17 May 2012. [http://www. guardian. co. uk/world/2009/jun/08/nigeria-usa] – John Vidal (13 August 2008). Shell rapped by ASA for ‘greenwash’ advert”. The Guardian(London). [http://www. guardian. co. uk/environment/2008/aug/13/corporatesocialresponsibility. fossilfuels] – Macalister, Terry (31 January 2007). “Campaigners urge Shell to put profits into clean-up”. Business (London: Guardian News and Media Limited). Retrieved 30 August 2007. [ http://www. guardian. co. uk/business/2007/jan/31/oilandpetrol. energy] – IMF World Economic Outlook, Sept2011 [Available from: http://www. imf. org/external/pubs/ft/weo/2011/02/] – GEORGE ATHANASSAKOS. Beware the value trap: Oil stocks are not as cheap as they look. Special to The Globe and Mail. Published Tuesday, Jul. 17 2012. [http://www. heglobeandmail. com/globe-investor/investment-ideas/beware-the-value-trap-oil-stocks-are-not-as-cheap-as-they-look/article4424367/] JOURNAL ABSTRACTS: – Robert Huebscher. Burton Malkiel Talks the Random Walk. July 7, 2009. [http://www. advisorperspectives. com/newsletters09/pdfs/Burton_Malkiel_Talks_the_Random_Walk. pdf] –  The Cross-Section of Expected Stock Returns, by Fama & French, 1992, Journal of Finance [http://ideas. repec. org/a/bla/jfinan/v47y1992i2p427-65. html] – Overreaction, Underreaction, and the Low-P/E Effect, by Dreman & Berry, 1995, Financial Analysts Journal[http://www. cfapubs. org/doi/abs/10. 2469/faj. v51. n4. 1917] Firm Size, Book-to-Market Ratio, and Security Returns: A Holdout Sample of Financial Firms, by Lyon & Barber, 1997, Journal of Finance[http://ideas. repec. org/a/bla/jfinan/v52y1997i2p875-83. html] – Stock & competitor 5year returns chart: www. googlefinance. com. [Available at: http://www. google. com/finance? chdnp=1&chdd=1&chds=1&chdv=1&chvs=Linear&chdeh=0&chfdeh=0&chdet=1351338332967&chddm=1509&chls=IntervalBasedLine&cmpto=LON%3ABG%3BEPA%3AFP%3BLON%3ABP&cmptdms=1%3B0%3B1&q=AMS%3ARDSA&ntsp=0&fct=big&ei=E8mLUPC2J-GXwQOjqQE] – Sylvia, P. and Thompson, C. Shell plans $100 investment drive. Financial

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