Shell (RDSB) faces what amounts to an almost existential crisis: even when oil prices were $100 its portfolio was strewn with problems. Huge bets on shale destroyed huge amounts of capital, cost overruns on key projects such as the Motiva refinery, and a chronically poor-performing downstream all combined to leave the company with very weak returns on capital.
We have recently lowered our Shell fair value estimate to £20.50 per share from £21 per share to reflect what we believe was an overpayment with respect to its planned acquisition of BG Group.
The implied £13.50 offer price is roughly 11% above our £12 BG fair value estimate. We risk the valuation impact of the deal by 5% to reflect the possibility that it does not go through as anticipated. Regulatory or antitrust approvals are needed from the European Union, Brazil, China, and Australia. If all goes to plan, this acquisition will close in 2016.
Does Shell Have an Economic Moat?
Given our view that long-term oil prices will be well below $100 going forward because of the emergence of low-cost US tight oil, we don't believe Shell's assets are cost-advantaged enough to provide it with a lasting competitive advantage that will allow it to generate excess returns on capital. Despite plans to lower capital spending, cut costs, and delay high-cost projects, we believe Shell will continue to generate weak returns on capital for the foreseeable future.
The core issue here is that Shell is simply too high up the global cost curve and lacks meaningful exposure to high-quality U.S. oil and gas shale resources. Additionally, its downstream footprint is geographically disadvantaged and is underexposed to cost-advantaged markets such as the U.S. Gulf Coast and midcontinent. This segment is thus also a drag on returns. Adding it up, we don't believe that Shell still possesses an economic moat.
