Image source: Olaf Kraak via Shell plc
Shell’s (LSE: SHEL) share price has tracked the benchmark Brent oil price higher this month. However, the stock is still down 6% from its 13 May one-year traded peak of £29.56.
I think even that 12-month high is nowhere near the fair value of the energy giant. And I think a turning point in realising its full potential may be yesterday’s (25 March) strategy update.
What’s the new idea?
At its Capital Markets Day, it broadly announced its aim to become the world’s leading gas and liquefied natural gas (LNG) business.
Gas is the key energy source in transitioning from fossil fuels to greener alternatives. And LNG became the world’s emergency energy form after Russian oil and gas were sanctioned following its 2022 Ukraine invasion.
Unlike oil and gas moved through pipelines, LNG can be sourced, bought, and moved quickly anywhere in the world.
Given this, Shell forecasts global LNG demand will rise 60% by 2040. It already has major LNG projects in 10 countries and 38m tonnes of its own capacity from 11 liquefaction plants.
But it now plans to increase its LNG sales 4%-5% — and production 1% — a year in the next five years.
Boost for shareholder returns
A risk here is that these market projections do not pan out due to long-term changes in supply and demand.
However, Shell also pledged to enhance shareholder distributions to 40%-50% from 30%-40% of cash flow from operations. This will focus on share buybacks, which tend to support share price gains.
At the same time, it will maintain its 4% a year progressive dividend policy. This is where a dividend is expected to rise at least in line with increases in earnings per share. However, if this falls, the dividend will not be reduced.
The dividend for 2024 was actually raised 7.8% — to $1.39 (£1.07) from $1.29. This gives a current yield on the £27.71 share price of 3.9%.
Analysts forecast the yield will rise to 4.1% in 2025, 4.2% in 2026 and 4.5% in 2027.
They also project that Shell’s earnings will rise by 6.2% a year to the end of 2027. It is this growth that ultimately drives a stock’s price and dividend higher over time.
However, to further boost its capital base, it will target cost reductions of $5bn-$7bn by end-2028 versus 2022.
Are the shares a bargain?
Shell’s 13.6 price-to-earnings ratio is bottom of its group of competitors, which average 15.4.
These comprise ConocoPhillips at 14.2, ExxonMobil at 15, Saudi Aramco at 16, and Chevron at 16.5.
So, Shell looks a bargain on this measure.
The same applies to its 1.2 price-to-book ratio compared to its peers’ average of 2.5. And it is also true of Shell’s 0.8 price-to-sales ratio compared to the 2.2 average of its competitors.
I ran a discounted cash flow analysis to put all this into share price terms. Using other analysts’ figures and my own, this shows Shell shares are 39% undervalued at their present £27.71 price.
Therefore, the fair value is £45.43, although they may go lower or higher than that.
Given its earnings growth forecasts and the positive effect these should have on its share price and yield, I will buy more Shell shares very soon.
