Shell and BP: upgrades, new price target and bigger dividends

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The compelling valuation of a catalyst-rich BP (LSE:BP.) and the scope for faster Shell (LSE:SHEL) dividend growth have been flagged by a City bank in its annual deep dive of Europe’s Big Oil sector.

Morgan Stanley is Overweight on both FTSE 100-listed stocks, but with Shell its top pick based on expectations that an acceleration in its pace of shareholder distributions will bring its market value closer to where the company’s fundamentals already are.

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The bank’s price target for Shell of 3,780p compares with today’s level of 3,509p, while BP has been valued at 598p after a period of boardroom upheaval caused shares to lag the sector at 556.1p.

Morgan Stanley said BP’s underperformance left various metrics “genuinely attractive” compared to peers, including cash generation relative to market capitalisation. With $17 billion (£12.6 billion) of free cash flow expected in 2027, a 15% yield is well ahead of the peer group average of 11%.

On the balance sheet, the impact of much higher commodity prices and suspension of share buybacks, means the bank sees net debt falling to below the bottom of BP’s own target range a full year early and that it will move into a small net cash position during 2027.

The Overweight stance is also supported by BP’s improved upstream growth outlook, which is driven by recent exploration successes and an improvement in reserve replacement ratio to 90% in 2025 from an average of around 50% over the prior two years.

Morgan Stanley adds that BP is relatively catalyst rich, given the potential for a restart of share buybacks and start of the appraisal campaign on its Bumerangue oil field discovery in Brazil.

Based on expectations for normalised free cash flow in the $11-12 billion range and 2-3% reduction in share count from 2027 onwards, the bank sees the potential for the dividend to grow by 10% a year within the 2028-30 time frame.

BP today announced that the sterling conversion on its upcoming quarterly dividend due for payment on 18 September is 6.4059p a share, having increased the award by 4% versus last year and the previous quarter to 8.66 US cents a share.

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Shell told shareholders yesterday that its second-quarter dividend in sterling terms will be 28.92p a share, which is down from the previous quarter’s 29.18p after no change in the dollar rate at 39.06 US cents a share. The payment is due on 21 September.

Morgan Stanley said Shell’s valuation has been held back by its dividend policy but that it now sees potential for a significant acceleration. Shell shares outperformed peers during 2023, 2024 and the first half of 2025, but then went into reverse shortly after.

Despite underlying improvements to the business, the bank notes that Shell’s total quarterly dividend has risen at a compound annual growth rate of 2.1% over CEO Wael Sawan’s tenure.

The increased outlay from $2 billion in the fourth quarter of 2022 to $2.2 billion in the most recent quarter is below the rate of US inflation of 2.8% over the same period.

At the current level of share buybacks worth $14 billion a year, the annual dividend is still only forecast to grow from $9 billion in 2026 to $10.4 billion by 2030.

As buybacks appear to have failed fundamentally to re-rate the shares, the bank suspects that after three and a half years Shell management will move away from that preference and start giving more priority to dividend growth.

The bank said there were a series of milestones that could trigger additional bumps on top of the underlying 4% dividend growth rate.

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These include the recent acquisition of Canada-based ARC Resources, which is set to add around $1.5 billion to annual free cash flow, and the planned sale of its US chemicals assets.

Morgan Stanley said: “The same dividend discount model that pulls the shares towards 2,900p at a 4% long-term dividend growth rate would underpin a valuation of 3,700p with a 10% dividend per share growth rate into the early 2030s.

“A return to more significant [dividend per share] growth would highlight management’s confidence in the company’s long-term outlook, and would be a significant positive catalyst.”

The bank’s positive stance on Shell and BP was disclosed in its annual deep dive into the upstream positions of Europe’s major oil and gas firms.

It said data sourced from Wood Mackenzie and Rystad Energy showed that the sector is rapidly deepening its resource base.

Driven by developments in Canada, the United States, Qatar, the UAE and Iraq, it forecast an increase in the 2025-30 growth rate to 2.9% a year from 1.2% last year. There is also visibility on production growth out to 2032, compared with the horizon of 2030 in last year’s report.