I’m not always a fan of share buybacks but, in the case of Shell (LSE: RDSB) (NYSE: RDS-B.US), it’s making me consider buying more shares because I think it is a sign that the company is hugely undervalued.
Indeed, Shell is persisting with a vast share buyback programme that few of its peers can match. It is in the process of buying back between $4 billion and $5 billion worth of shares, equivalent to around 2.6% of the combined market capitalisation of its ‘A’ and ‘B’ shares.
It expects to complete these repurchases during the current financial year, and it would be of little surprise to me if it made plans to continue buying back its own shares into 2014 and beyond.
Indeed, the mere purchase of shares is not what excites me, rather that I think it is a great way to utilise surplus cash that does not need to be reinvested in the business to develop the company’s asset base.
Furthermore, with shares currently offering great value, I think it is the perfect time for Shell to be delivering such a vast buyback programme. Indeed, evidence of the great value that shares currently offer can be seen in the company’s price-to-earnings (P/E) ratio, which is just 8.5 when using earnings for the current financial year.
This is extremely attractive, especially when the FTSE 100 trades on a P/E of just under 15 and the wider oil & gas industry group has a P/E of 12.2. Shares trading at such a wide discount should, in my view, be bought back where possible by the company itself.
In addition, the attractive value of Shell’s shares can also be seen in the free cash flow yield, which stands at 5.3%. This is highly impressive and, in my view, has the potential to improve as capital expenditure becomes more focused and concentrated in future years.
So, I’m bullish on Shell because I think its share buyback programme is the perfect policy for it to be following. It is vast and will help to support the share price in the short run, while I’m convinced that it is the right time to be doing it as a result of the P/E and free cash flow yield ratios being so attractive.
