Shell's ruthless focus on value triggers big price target upgrade

The oil major's asset profitability has ranked bottom of its peer group, but there's a potential fix that could improve its valuation. This is a big deal for shareholders, says a City expert.

A “ruthless” focus on value by the new team running Shell (LSE:SHEL) has been backed to trigger a big turnaround for the oil giant’s underperforming share price.

Deutsche Bank expects recently-appointed CEO Wael Sawan to push through the required financial, cultural and behavioural changes that will improve asset profitability, otherwise known as return on average capital employed (ROACE).

• Learn more: SIPP Portfolio Ideas | How SIPPs Work | Transfer a SIPP

Over the last three years Shell's average ROACE of 12.9% ranks bottom of its peer group and has been seen as one of the factors holding back its valuation.

While admitting it will take time to have an impact on $225 billion of capital employed, the bank’s assumptions see Shell's 2028 ROACE increasing to 15.2%.

That would leave Shell above the European sector average of 13.7% forecast for that year and behind only Equinor ASA (XETRA:DNQ)and UK peer BP (LSE:BP.).

It expects to see a focus on higher value capital expenditure, cost savings of up to $3 billion by 2025 and increased efforts to dispose of lower quartile assets and businesses.

Under Sawan’s leadership and supported by a new finance boss and recently-appointed head of upstream operations, Deutsche Bank believes that Shell now has a clear strategy that “essentially boils down to a pragmatically ruthless focus on value”.

As every 100 basis point improvement in ROACE has the potential to add 8% to 2023 earnings per share (EPS), the bank has raised its EPS forecasts by 5% and 9% for 2024 and 2025 respectively based on unchanged oil and gas price forecasts.

It increased its target share price by 12% to 3,268p for a 37% upside that is the largest in its European coverage. Risks to its valuation include a fall in LNG demand, further carbon Scope 3 taxes, and opposition to investments in oil and gas projects.

The bank said: “Shell's ROACE has long lagged key peers and this has possibly been a headwind for relative share performance at times.

“By the same token it is also a perennial source of potential upside, if a management team can unlock more of the undoubted value-creation potential of Shell's engineers and portfolio of upstream, midstream and downstream assets.”

• ii view: Shell warns on quarterly gas trading decline
• The Income Investor: dividend stocks still beat bonds and two shares I like
• Merryn Somerset Webb: the scariest chart in the world

Shell’s dividend yield of 4.6% is below the sector's 6.3% but including buybacks the total distribution yield of 11.7% is mid-ranking.

However, Deutsche Bank notes that Shell’s sector-leading 2024 free cash flow yield forecast of 15.4% points to the capacity to increase the ordinary dividend payout.

Sawan told investors and analysts in New York recently that he planned to increase shareholder distributions to 30-40% of cash flow from operations through the cycle. A 15% increase in dividend to around $0.33 a share is due to be confirmed alongside second quarter results on 27 July and will be distributed to shareholders on 18 September.