While the FTSE 100 has been a huge disappointment in 2015, being down 7% year-to-date, Shell (LSE: RDSB) has fared worse, much worse. In fact, the oil major has lost 31% of its value since the turn of the year and according to most investors a similarly dire performance next year is very much on the cards.
That’s because the oil price is showing no sign of stabilising, let alone mounting a sustained comeback. A glut of supply that’s apparently set to continue over the near term, combined with weak demand, means a sub-$40 oil price could be a feature of 2016. In such a scenario Shell could once again underperform the FTSE 100 by a significant amount.
Of course, a rising oil price would be very welcome news for Shell. It wouldn’t only improve investor sentiment in the company (and the wider sector), but would also boost its profitability. Clearly though, predicting the oil price is nigh-on impossible. As such, taking a longer term view of Shell appears to be a prudent move.
On this front, Shell has real potential. That’s because it’s taking the necessary decisions to take advantage of a low oil price. For example, its takeover of BG is expected to complete in early 2016. This has the potential to reduce the merged company’s costs by $2.5bn a year as well as to create a simpler, more profitable and more efficient merged entity. Furthermore, Shell is in the process of reducing its exploration spend and is seeking to lower its cost curve to maximise margins during what it is an exceptionally difficult period for the company.
With Shell trading on a price-to-earnings (P/E) ratio of 12.8, it appears to offer good value for money. This, combined with a forecast rise in the company’s bottom line of 7% next year, could be a potential catalyst to improve investor sentiment and push Shell’s share price higher over the medium term. In addition, Shell currently yields a whopping 8% and while a dividend cut is a realistic threat, dividends are set to be covered by profit next year. This indicates that they may not be slashed as heavily as the market is currently anticipating.
In fact, if the FTSE 100 has another lacklustre year and the price of oil does stabilise, Shell could beat the wider index in terms of its total return (i.e. with dividends included). Looking at the company over one year though, could lead to disappointment for investors since the oil price remains hugely volatile and really could go either way.
The investment case for Shell, however, centres on it having a very strong balance sheet, excellent cash flow, a low cost base and further efficiencies to come from the BG deal. Factor in the very low valuation, and it means that on a longer term view, Shell is in a strong position to beat the FTSE 100. As such, now appears to be a sound moment to buy for 2016 and beyond.
