The three oil majors have recently published their fourth quarter results, so we can finally crunch the numbers and see which of them fared better during 2021. It has been a very good year for oil and gas companies as prices climbed from the pandemic lows and the companies registered impressive profits, putting behind the ugly results of 2020.

In this article, I will compare the numbers from their latest report to have a better idea about the size and profitability of each oil major, and see how expensive the companies are in the current market compared to each other.

Summary

• A comparison of the 2021 full year results of the three oil majors.

• See how the big three compare when it comes to sales, earnings, cash flows, capital expenditures, dividends and debt.

• Shell is extremely undervalued compared to the other majors.

• At current oil prices, Shell generates a lot of extra cash after capex and dividends that it can use for buybacks and debt repayment.

• If you want exposure to the energy market, Shell is the best choice, as it is the most diversified and the cheapest at the same time.

Revenue, Earnings & Valuation

With the 2021 numbers finally available from all three majors, I have compiled the most important metrics into several spreadsheets to see how they stand.

When it comes to revenues, Exxon is the leader with $285 Billion, closely followed by Shell with $272 Billion. Chevron comes a distant third with only $155 Billion in sales.

Based on the 2021 earnings, the companies are ranked in the same order with Exxon leading the pack ($23 Billion in profits) followed by Shell ($19 B) and Chevron ($15.6 B)

Now, if we look at the valuation, the situation is a bit different.

The shareholder equity on the balance sheet of the three companies shows Shell in the lead ($175 B), followed by Exxon ($161 B at the end of the third quarter, as I couldn’t find the information in their fourth quarter report, so probably it is a bit higher than that considering the positive quarter) and Chevron ($139 B).

The difference in shareholder equity between the three is not very big (Shell’s equity is only 26% higher than Chevron’s), but this is only accounting stuff, so we should look at the market value to see how investors view the companies. Here, the situation changes dramatically:

Exxon is in the lead with a market cap of $337 B (as of today, February 5th 2022) followed by Chevron $258 B and Shell at only $212 B. The market capitalization of Exxon is 59% higher than that of Shell, despite the fact that the shareholder equity of Shell is a little higher, and the revenue and earnings numbers are pretty close. This is because Exxon and Chevron are valued at higher multiples by the market.

When it comes to Price to Sales, Price to Earnings and Price to Book Value, Shell is by far the cheapest of the three. Chevron is the most expensive based on sales and earnings while Exxon is the most expensive based on book value.

Of course, there must be some reasons for this, so we should dig deeper. What about cash flows, capital expenditures and dividends?

Cash Flows, Capex and Dividends

How do the big three compare when it comes to Cash Flow From Operations (CFFO), planned Capital Expenditure and Dividends?

The cash flows show a significant difference compared to the earnings. Shell is the leader of the pack when it comes to Cash Flow From Operations ($55 B), followed by Exxon ($48 B) and Chevron ($30 B).

Despite having the lowest market capitalization among the three, Shell generates the most cash from operations.

The Capex has been lower in 2021, but I have used the planned Capex for the following years in the above table, as all three companies are planning for increased Capex in 2022 compared to 2021. For Shell and Exxon, which both gave a Capex range in their guidance, I have used a moderate number from their range.

We can see that Shell plans to spend the most (approx $24 B per year) followed by Exxon (22 B) and Chevron (15 B). It is well known that Shell is trying to build its “new energy” business on top of maintaining its current oil & gas business (with the oil business being allowed to slowly decline), so the higher Capex budget comes at no surprise.

Subtracting the Capex from the Operating Cash Flows we end up with the Free Cash Flow, where Shell is again the leader of the pack, despite having the lowest market capitalization. If cash flow generation would be the same as in 2021 while using the guided Capex budgets for 2022, Shell would remain with a FCF of $31 Billion, followed by Exxon with $26 Billion and Chevron with $15 Billion.

If we adjust the Free Cash Flows with the market capitalization of the companies, Chevron is the most expensive with a Price to FCF of 17.2, followed by Exxon at 12.96 and Shell with only 6.83. Based on Free Cash Flow yield, Chevron is 2.5 times more expensive than Shell!

The dividends are another interesting point. Exxon paid the most dividends in 2021 ($15 B), Chevron came in second ($10 B) while Shell paid the least ($6.7 B). It is easy to notice that Shell’s dividend burden is less than half that of Exxon, because the infamous dividend cut by Shell. However, considering the fact that Shell generates the most FCF and pays the least in dividends, we notice that the extra cash after dividends hugely favors the British company.

If cash flows would stay the same in 2022, Shell would have $24 Billion in extra cash after dividends to spend on debt repayment or buybacks. In comparison, Exxon would have only $11 Billion and Chevron only $5 Billion.

Debt Reduction, Net Debt and Enterprise Value

All three oil majors have reduced debt during 2021, since they benefited from good oil prices while keeping Capex in check. Here is a detailed look:

Shell cut its net debt by the most ($23 B) closely followed by Exxon ($20 B) and Chevron ($13 B). All three companies did very well in reducing debt last year. However, Shell still remains the most indebted of the three, despite reducing debt more aggressively. With $52 Billion in Net Debt, Shell is twice as indebted as Chevron ($26 B). This shows that there is still some work to do on the gearing front for Shell, and the extra cash should be used to further reduce debt.

Ranked by Enterprise Value, Exxon is the clear leader ($378 B) followed by Chevron ($284 B) and Shell ($264 B). It is interesting to note that when it comes to revenue, profits and cash flows, Exxon and Shell are comparable in size, while Chevron is clearly smaller. On the other hand, when it comes to Enterprise Value, Shell and Chevron are comparable in size while Exxon is a lot bigger. This shows that the market clearly favors the US companies which have a clear price premium right now.

When ranking the big three by EV to Sales, Earnings and Free Cash Flows, a pattern emerges. Chevron is always the most expensive, followed by Exxon and then Shell, which is always a lot cheaper.

Diversification at a Reasonable Price

Considering the 2021 numbers, we can easily conclude that Shell is performing just as well as its main rivals from an operational point of view, but its share price doesn’t reflect that.

I believe there are three reasons for Shell’s undervaluation:

1) UK companies usually trade at lower multiples than their US peers

2) The dividend cut alienated many investors

3) The management’s wish to transition the company to a more “Green Energy” company is disliked by many oil investors, while its current oil portfolio makes it unloved by the green energy crowd. This means that Shell is unloved by both oil and “green” investors.

However, undervaluation is what creates opportunities for value investors.

The current situation presents a very good opportunity for those who own shares in Chevron or Exxon to sell and buy Shell instead. With such a trade, they can greatly increase their free cash flow yield by profiting from the valuation difference. By making the switch between majors, an investor will keep the same exposure to the oil and gas sector, but will benefit from higher potential returns thanks to the lower valuation, as well as hedging the risks from the energy transition, since Shell is more diversified and is also building a “green energy” division.

The low valuation presents Shell investors with huge benefits. They can benefit in both scenarios, when the valuation gap closes, and when the valuation gaps remain.

Two Scenarios, the Same Winner

When it comes to the valuation gap between Shell and the two US oil majors, there are two potential scenarios:

1) The Valuation Gap Closes in the Future

If Shell and its peers will trade at similar multiples in the future and the valuation gap will close, Shell’s shareholders are poised to benefit compared with Exxon or Chevron shareholders.

Closing the valuation gap simply means that Shell’s price will fare better than its peers, so making the switch now would turn into an excellent trade.

2) The Valuation Gap Stays for the Long Term

While this scenario doesn’t seem to benefit Shell’s shareholders, the reality is that even in this case they are at an advantage and the trade still makes sense. This is because asset sales and share buybacks are a lot more effective for a company that trades at cheaper multiples.

All three oil majors are planning share buybacks right now. Shell is at an advantage because the return on its buybacks are much higher because of the lower valuation. If the valuation gap persists for years, all the share buybacks done during this period will generate a higher increase in earnings per share for Shell than they will for Exxon or Chevron. This means that Shell has the potential of better EPS growth thanks to buybacks, as it has a higher return on its buybacks.

Asset sales can give another boost to Shell, because the lower price means Shell can sell assets and buyback shares with the proceeds. If the assets that are sold have a lower return than the buybacks, the result is an increase in EPS. This strategy can only be executed when a company trades below its real value. The sale of its Permian assets and the subsequent buybacks show that Shell’s management is well aware of this opportunity and it is currently executing this strategy.

As long as Shell remains undervalued, it can use buybacks and asset sales to boost earnings per share and profit from the undervaluation. This means that earnings per share can grow faster while the company is undervalued.

Combining this with the fact that Shell has the highest cash flows and the lowest dividend expense, means Shell is in a position to grow its EPS at a much better rate than its rivals.

Risks

While all oil and gas companies are exposed to the oil price risk, trading oil majors among them doesn’t increase this risk, since you keep the same exposure to the sector and the price risk.

However, trading the likes of Exxon or Chevron for Shell has its own specific risks.

Shell clearly stated that its strategy is to slowly move away from oil and turn into a “green energy” company. This strategy comes with its own risks, as nobody knows how this transition will work out and if the alternative energy investments will have good returns or not. Shell will remain an oil and gas company for a long time, but it is slowly shrinking its exposure to oil, while keeping a very strong position in LNG. It is also willing to become a major player in the hydrogen space.

On the other hand, Exxon and Chevron are more exposed to oil and are less aggressive when it comes to the energy transition.

If Shell’s transition fails, the trade may not be as effective, despite the advantages coming from the current valuations.

Conclusions

After analyzing the 2021 numbers of the big three, I came to several conclusions:

• Shell is a lot cheaper than Exxon and Chevron.
• The market has punished Shell for the dividend cut and the transition to alternative energies.
• Shell generates the most free cash flows and pays the lowest dividend. This means it has a lot more extra cash to spend on buybacks or to pay down debt.
• The lower valuation means buybacks are more effective and result in a higher increase in earnings per share.
• If the valuation gap closes, Shell’s share price will overperform its peers.
• Selling Exxon or Chevron and buying Shell can result in a much higher FCF yield and better long term return for your investment.

While there is no certainty about the future operational results of the three majors, 2021 showed that during elevated oil and gas prices all of them are able to generate huge profits and cash flows. If 2022 will continue the uptrend in energy prices, the three majors could further reduce their debts while at the same time they could engage in larger share buybacks (which Exxon and Shell already announced).

Because of Shell’s undervaluation, the return on buybacks is higher and the resulting increase in EPS will be higher.

I recommend trading Exxon or Chevron for Shell as the undervaluation creates a great long term opportunity.

The current lower dividend yield will be offset by better share price performance and higher dividend increases in the future.