Shell’s (LSE: SHEL) share price has fallen 10% since its 18 October high this year. I think the main reason for this is the decline in oil prices over that period.
There are risks in the stock, of course, with one being a sustained slump in global commodities prices. Another is government clampdowns on its operations because of the switch to greener energy.
However, this sell-off overlooks key factors that support share price gains over the long term, in my view.
And I am seriously considering adding to my holdings of Shell stock at the currently discounted level.
Oil prices change all the time
Broadly, oil prices have lost ground since the end of September on lower demand from key buyers. But the global balance between demand and supply constantly changes, and oil prices with it.
Short term, any widening of the Israel-Hamas War could cause a price spike, for example. The World Bank said recently that the Brent benchmark price could soar to over $150 per barrel in this event. Currently, it is around $76.
Long term, the transition to greener energy will likely take much longer than many analysts estimate. In October, OPEC forecast that world oil demand will rise to 116m barrels per day (bpd) by 2045. Currently, it is around 100m bpd.
The International Energy Agency added recently that government pledges fall well short of achieving greenhouse gas ‘net zero’ by 2050.
Well positioned for the energy transition
Shell has both sides of the energy transition covered. On the one hand, it committed to keep oil production at 1.4m bpd until 2030. It also said it will expand its huge liquefied natural gas business.
To this end, it continues to make new oil and gas discoveries, including several major oil finds in Namibia recently. These together are estimated to hold at least 1.7bn barrels of oil equivalent.
In February, it said its recent gas discovery in the UK’s Southern North Sea could be one of the largest in over a decade.
This is in line with CEO Wael Sawan’s intention to close the valuation gap between Shell and its US counterparts. Despite Joe Biden’s greener US administration, these firms have remained committed to their core oil and gas businesses.
On the other hand, Shell aims to reduce its carbon emissions gradually – down 20% by 2030, 45% by 2035, and 100% by 2050.
Meanwhile on 2 November, it reported earnings of $6.2bn for Q3, against Q2’s $5.1bn. Earnings per share of $1.06 were up from Q3 2022’s $0.93.
Cheap against its peers
Shell’s price-to-earnings (P/E) ratio has improved since Sawan took over this year – from 4.9 at the end of 2022 to 7.1 now. But there is still plenty of room to rise before it catches its peers’ P/E valuations.
While Brazil’s Petrobras is low and trades at 3.3, the US’s ExxonMobil and Chevron are 9.7 and 10.7, respectively, and Saudi Arabian Oil is at 16.8.
Given the peer group average of 10.1, Shell looks very undervalued.
To work out by how much, I applied the discounted cash flow (DCF) model, using several analysts’ valuations and my own.
The core assessments for Shell are between 26% and 40% undervalued. The lowest of these would give a fair value per share of £34.05, against the current £25.20.
