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Can we still be sure of Shell?

Screen Shot 2016-08-19 at 09.42.13By Kevin Godbold – Friday, 19 August, 2016

Our investing forefathers used to trot out the maxim ‘never sell Shell’. Years ago, Shell was a fast-growing business in a fast-growing market, so holding on to Shell shares indefinitely made more sense back then than it does now.   

Today, Royal Dutch Shell (LSE: RDSB) is a mature business in a mature market and its fortunes tend to ebb and flow with the undulations of wider macroeconomic cycles. Adopting a long-term buy-and-hold strategy for Shell now seems inappropriate.

A tempting valuation?

When the oil price plunged recently, so did Shell’s shares. However, even after the impressive recovery the shares have put in so far this year, Shell still looks attractive on traditional valuation indicators. 

At a share price around 2,000p, the forward price-to-earnings rating for 2017 runs at just over 13 and the forward dividend yield is a tad over 7%. City analysts are pencilling-in a dramatic earnings recovery for Shell next year, perhaps speculating (at least to some degree) that the price of oil will recover more ground from here. 

But the oil price isn’t the only factor driving profits. Shell will be working hard to push down costs and to optimise returns from new assets acquired with the takeover of BG in February. 

Aiming for stronger cash flow

In July, with the firm’s half-year results, CEO Ben van Beurden said Shell is looking through the cycle, and investment plans and portfolio actions are focused on reshaping Shell into a world-class investment case through stronger, sustained and growing free cash flow per share.

So does that mean Shell will be one to ‘never sell’ again? I don’t think so. The recent dramatic V-shape that cleaves through the share price chart underlines Shell’s ongoing vulnerability to macroeconomic cycles as expressed in the supply and demand outcomes that keep the price of oil jumping around.

Looming market decline

But there’s a bigger reason than mere cyclicality that stops me from being enticed by Shell’s big dividend and low valuation. Unlike in Shell’s earlier years of existence, the market for oil is now mature and not growing. Arguably, demand for oil could decline in the near term as disruptive technologies usurp oil’s once impenetrable place as the fuel of choice for transport, heating and power.

These days, it feels as if I can’t drive for very long without spying a field full of solar panels or a hilltop sprouting wind generators. Electric cars are set to hit the big time as battery technology advances. Levels of insulation in newly built homes arguably make heating far less important than it once was.

Shell operates in a mature market that faces decline and the firm is buffeted by the winds of cyclicality. If I had to come up with a new maxim for today’s investors tempted by Shell’s dividend it might be ‘never forget Shell’s vulnerability’.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

SOURCE

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

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