Despite the savage fall in the price of oil in recent months, shares in Shell (LSE: RDSB) (NYSE: RDS-B.US) have held up remarkably well compared to many of the company’s sector peers. Indeed, over the last year Shell has seen its share price rise by 1%, which, given the fact that oil is less than half of its value back then, seems like a remarkable result.
And, looking ahead, Shell could deliver even better gains and could be worth 2,880p.
A New Strategy
A key reason why shares in Shell have outperformed rivals in recent months is the company’s new strategy, which has boosted investor sentiment. For years Shell was seen as a bloated company that was so big and so diversified that it did little to add value and generate significant returns for shareholders.
However, with a new management team at the helm, Shell is undergoing a transformation that, although not yet particularly advanced, involves selling off divisions that are either too unprofitable or require too much capital, and keeping the most appealing ones in order to make the company more efficient and, in time, more profitable.
Valuation
Clearly, a new strategy will take time to make a real difference to the company’s bottom line — especially when lower oil prices are causing a decline in sector-wide profitability. And even though Shell’s shares are up 1% in the last year, the company still trades on a very low valuation that offers a considerable margin of safety.
For example, Shell has a forward price to earnings (P/E) ratio of just 11.7, which takes into account the forecast fall in earnings of 19% next year. This is low on an absolute basis, but is even more appealing on a relative basis, since the FTSE 100 trades on a P/E ratio of 15.3.
As such, Shell could see its rating move upwards to narrow the current valuation gap and, were it to trade on the same P/E ratio as the FTSE 100, it would equate to a share price of around 2,880p. This would represent a capital gain of 31% from its current share price.
Looking Ahead
Clearly, a continued fall in the price of oil would be likely to hurt Shell’s profitability even further, which would make a price of 2880p less likely. However, Shell’s current share price includes a significant margin of safety so that, even if the price of oil does decline, it is unlikely to hit Shell’s share price as hard as you may expect.
With such huge capital gain potential on offer, a new strategy, and highly appealing diversity, Shell could prove to be an excellent buy at the present time.
