Shell shares still undervalued

They've raced higher over the past couple of years, but Graeme Evans has found an expert who still rates Shell shares a 'buy.' 

Even though the pumps are still dry on Royal Dutch Shell B's promised $25 billion share buy-back, analysts at Barclays have been looking ahead to the kind of sums eventually needed for the oil giant to be a truly world-class investment.

Their conclusion is that there are some significant levers the Anglo-Dutch company can pull to merit a 3250p target price, an upside of 20% on today.

The equity research team at Barclays also state that for Shell to achieve its ambition of being world-class on a multi-year basis it must be able to show it can improve cash returns to shareholders almost regardless of the oil price.

For that to happen, much will depend on the free cash flow (FCF) performance in Integrated Gas and in Shell's downstream estate covering its refining and marketing operations.

As part of its research, the Barclays team spent time among the sausage rolls at UK service stations and travelled to a proposed LNG site in Canada to see at first hand the prospects in Shell's Integrated Gas division.

Both trips covered what are key areas for the Shell investment case, with Barclays estimating that a combination of FCF in Integrated Gas and downstream alone could generate as much as $25 billion a year by 2025.

This far exceeds the $15 billion annual dividend requirement and increases the likelihood that a $10 billion a year share repurchase scheme can continue well into the next decade.

Shell is committed to a $25 billion buy-back between 2018 and 2020, but to the frustration of investors hasn’t started the scheme yet.

Barclays believes the company may want to be sure it can continue buy-backs in any reasonable oil price environment before starting. A further update on progress is likely to come with Shell’s half-year results on July 26.

In the meantime, the Barclays team think the FTSE 100 stock looks undervalued:

"Should confidence grow in cashflow over coming quarters, we expect the 8% dividend and buyback yield that the shares offer to become increasingly attractive."

Source: interactive investor      Past performance is not a guide to future performance

They are particularly taken by the potential in downstream, with Shell being one of the largest retailers in the world with more outlets globally than Starbucks and serving over 30 million customers a day.

The site visits to UK petrol stations also highlighted to Barclays how much opportunity there still is to increase profitability, even in a mature market.  

If Shell is to achieve the upper end of its FCF $9 billion-$12 billion ambition in downstream  by 2025, Barclays notes this would imply a potential further 230p-300p upside to its net asset valuation.

The Integrated Gas business, meanwhile, is set to generate $8 billion-$10 billion of FCF by 2020, which on Barclays estimates could rise to $15 billion by 2025 to reflect growing volumes in a tightening market.

They add: "We see a rapidly tightening LNG market emerging from 2020 with trade volumes of LNG to continue to increase at a fast pace. Shell's dominant market position puts it in a leading position to benefit from this."