Image source: Olaf Kraak via Shell plc
Shell’s (LSE: SHEL) share price is down 15% from its 5 July 12-month high of £29.10. Comparing its share price chart with that of the Brent oil price benchmark shows a near-identical trading pattern.
In basic terms, this implies that the UK oil giant has no additional value over and above the oil price. That is, no additional value from its high-value petrochemical products, green energy products, trading operations or anything else.
Handily though, the value of the likely future cash flows from all of Shell’s operations can be seen via discounted cash flow analysis.
It pinpoints the price any firm’s share price should be, based on future cash flow forecasts for the underlying business.
This allows me to get a clear picture of the difference between Shell’s share price and its share value. The two are not the same and it is in this difference that big, consistent profits are made over time, in my experience.
This comprises very senior trading and sales positions at investment banks and 35 years as a private investor.
So, what’s the valuation?
Using other analysts’ figures and my own, the DCF for Shell shows it is 62% undervalued at its current price of £24.79.
Therefore, the ‘fair value’ of the shares is £65.24.
A comparison of the firm’s key stock measures against those of its competitors lends further weight to this view.
Its 0.7 price-to-sales ratio is very undervalued against its competitors’ average of 1.9. Indeed, it is bottom of the group that comprises Chevron at 1.2, ExxonMobil at 1.3, ConocoPhillips at 1.9, and Saudi Aramco at 3.4. And it is apposite to note that this ratio includes all sales made by the company, not just of oil.
It is also very undervalued at a price-to-book ratio of 1.1 compared to the 2.3 average of its peers.
How does the business look?
I think a risk to Shell is any reversion to a more aggressive energy transition plan due to government pressure.
These included a target of reducing its net carbon intensity by a minimum 20% by 2030 compared to 2016 levels. It has since lowered this target to a minimum of 15%.
It also featured a 45% net carbon reduction target for 2035, which was subsequently scrapped.
Like its CEO, Wael Swan, I believe its earlier targets exacerbated the valuation gap between it and its still fossil-fuel-focused competitors.
Instead, Shell plans to keep oil production at 1.4m bpd until 2030. And it intends to expand its liquefied natural gas business, based on forecasts that demand will increase 50%+ by 2040.
Overall, consensus analysts’ estimates are that the firm’s earnings will increase 10.4% a year to end-2027.
Will I buy more of the stock?
It is earnings growth that ultimately drives a firm’s share price higher over the long run. Given the very undervalued starting point for such a rise, I cannot pass up the opportunity to buy more of the shares and will do so very soon.
An additional benefit of doing so is the healthy dividend yield of 4.3% currently. This compares to the 3.5% average yield of the FTSE 100 at present.
That said, analysts project that Shell’s yield will rise to 4.5% next year and to 4.7% in 2027.
