TheMotleyFool.co.uk: Shell Fishing

By David Kuo (TMFDragon)
April 29, 2004

They say that one of the best times to invest in a blue chip firm is when the company is on its knees. In the case of Shell the scandal-hit oil giant is not just on its knees, it is writhing on the ground in agony following the exposure of five years of fishy management decisions.

So is Shell a buy?

As with all investment decisions there are never any straightforward answers. After all, if investing in shares is that clear-cut we would all be exceedingly rich people!

In my view, there are a number of issues that need to be weighed. Firstly, have all the bad eggs been turfed out the company? At first glance, the ousting of chairman Sir Philip Watts, the sacking of gas chief Walter van de Vijver and, more recently, the demotion of bean counter Judy Boynton should draw a line under the issue of the key personnel responsible for overbooking proven oil reserves.

That leads on to the question of what precisely are proven oil reserves. These are oil deposits owned by the company that can be profitably extracted from the ground. The operative word here is "profitably", and as such the estimation of proven oil reserves will hinge on prevailing oil prices.

Recent reports appear to suggest that most of the world's easily extractable "cheap oil" has now been extracted. The days of Jed Clampett finding an oil gusher in his back garden are perhaps gone for good. So too is oil at below $20 a barrel. Additionally, demand for oil is unlikely to abate, especially with countries such as China insisting on more oil to lubricate its economic growth.

Thirdly, there are the ongoing investigations. In the UK the FSA is probing Shell, and in America there are investigations being undertaken by both the SEC and the Justice Department. These could be lengthy inquiries that could lead to criminal charges. Furthermore with lawsuits hanging over the company, Shell could remain uncomfortably in the spotlight for some time.

Finally, and perhaps most importantly, is whether Shell is cheap. The company today reported a 9% rise in adjusted first-quarter earnings to $4.2b, which was at the top end of market expectations. This prompted a 2% rise in its shares to 394p.

Cash flow from its operations was strong and this, coupled with shareholder pressure, has led the company to announce a $2 billion share buyback programme. Personally, I would prefer to see the cash returned in the form of dividends. That said Shell's dividend this year is forecast to be 16.2p per share rising to 16.7p per share in 2005. That indicates a prospective yield of 4.1%, which is quite healthy.

Investing in Shell could be a rocky ride in the short-term though, given the uncertainty surrounding the ongoing investigations. Consequently, nervous oil investors may prefer the UK's other blue chip oil alternative, BP (LSE: BP.).

In my view, however, Shell's shares should continue to be underpinned by its business performance and cash flow. Consequently, it should be a solid investment for those with a long-term view. After all there is more to Shell than a few bad eggs and overbooked oil reserves.

David owns shares in Shell.

http://www.fool.co.uk/news/Comment/2004/c040429a.htm?ref=lrninvadv