Are you tempted by the 12% fall in the Shell share price? Here’s what you need to know

G A Chester discusses the valuation and prospects of Royal Dutch Shell plc (LON: RDSB) and a small-cap peer with results out today.

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The share price of Royal Dutch Shell (LSE: RDSB) is down around 12% from its high earlier this year. Meanwhile, small-cap Igas Energy (LSE: IGAS), which released its half-year results today, has seen an even bigger pull-back, it’s shares being off 20%. Is this a great opportunity to buy a slice of these two businesses?

Rout

As the oil price crash a few years ago demonstrated, the volatility of black gold can have a devastating impact on smaller companies. They require high levels of capital investment for exploration and to bring their undeveloped assets into production, as well as ongoing maintenance expenditure on any producing assets they have. When the oil price is high, they may be profitable and have eager lenders willing to fund them. When the oil price crashes, profits can quickly turn to losses and high levels of debt can become a huge problem, if lenders decide not to continue their support.

This is what happened to UK onshore developer and producer Igas. It only survived the oil price rout with a financial restructuring that left its existing shareholders owning a small fraction of the business. At the same time, it provided new investors with an opportunity to buy into the company as a recovery play. With a repaired balance sheet and a rising oil price, Igas has made good progress, as today’s results show.

Recovery

The company reported a 26% increase in revenue for the first half of the year against the same period last year, and a rise in net cash generated from operating activities to £6m from £0.4m. Management reiterated its production and operating expenditure guidance for the full year. This underpins a two-analyst consensus forecast of £44.5m revenue and 6.15p earnings per share (EPS).

At a share price of 103.5p (5.6% up on the day), Igas’s market capitalisation is £126m. Its current-year forecast price-to-earnings ratio (P/E) is 16.8 and this falls to 13.7 next year on a consensus forecast of a 23% increase in EPS to 7.55p. While Igas isn’t a stock, I’d want to hold through the ups and downs of the oil price cycle, I think that in the current up-leg, there’s still plenty of upside for the company. As such, I continue to rate the stock a ‘buy’ at this stage.

Shell for sure

There are very few oil and gas stocks that I’d buy and hold for the long term. Shell is an exception and I rate it a ‘buy’ today after the decline in the share price to around 2,500p. There are only a few things you really need to know about Shell, in my view.

It’s market cap is over £200bn, making it the biggest company in the FTSE 100. Lenders can’t afford not to support it through the tougher times, unlike many smaller companies in the industry. There’s infinitely less risk for investors in Shell of having their capital entirely wiped out. And the behemoth’s resilience is evidenced by the fact that it continued to pay generous dividends throughout the period of the recent oil price collapse. In fact, it’s never cut its dividend since World War II.

The stock sports a current-year forecast P/E of 11.8, falling to 10.2 next year on City expectations of 16% earnings growth. With it also offering a running dividend yield of 5.8%, I see good value here at the present time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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