Energy giant Shell (LSE: SHEL) reported a $40bn record annual profit this morning, but the firm’s share price hardly moved.
In fact, Shell stock is worth no more than it was five years ago. What’s going on?
Record numbers
The FTSE 100‘s largest company smashed through City forecasts during the final quarter of 2022. Analysts covering the stock expected a fourth-quarter profit of $8bn. Shell reported a figure of $9.8bn, its second-best quarter of all time.
This strong finish pushed the group’s full-year earnings up to a record $39.9bn, double last year’s figure of $19.3bn. Shell’s previous earnings record was set in 2008, at $31bn.
Performance was boosted last year by strong oil and gas prices. However, Shell’s energy trading unit also played a big part in the result, delivering an increase of $8.6bn in earnings compared to last year.
Shareholders will be rewarded with a 15% increase to the fourth-quarter dividend and a $4bn share buyback. Purchasing shares and then cancelling them should help to support future earnings per share, especially if commodity prices ease.
Have profits peaked?
Shell’s last record profit came in 2008. Anyone who owned a car at that time might remember that this was when the price of oil rose to nearly $150 per barrel. Pump prices soared.
When oil prices fell to more normal levels, profits slumped.
Shell is a stronger business than it was then, with lower costs and better cash generation. I don’t think we’ll see profits collapse this year like they did in 2009.
Even so, I think it’s worth considering the risks.
Oil prices topped $120 briefly in 2022, but have since fallen to around $80 per barrel. Gas prices are also down sharply from last summer’s highs.
There’s a risk that we could see a widespread recession in 2023, which could dampen demand further.
City analysts expect Shell’s profits to fall by around 15% this year, to about $33bn. A further drop is predicted in 2024 — although to be honest, I’m not sure anyone can forecast oil prices that far ahead.
What I’d do with Shell shares
As I write, Shell is trading on around six times 2023 forecast earnings, with a useful 4% dividend yield. That doesn’t seem too expensive, but I’m not buying.
The reason for this is simple enough. Oil and gas profits have always been cyclical. I think this will remain true. On that basis, I reckon we could see several years of lower profits from Shell.
In addition to this, the company still has to prove it can adapt its business for the energy transition. Historically, renewables have generally been less profitable than oil.
I could be wrong. Some investors argue that the oil and gas sector has suffered from a lack of investment in recent years. Supplies could be tight over the coming decade, supporting higher prices for longer.
This could be true. But Shell shares are trading close to their all-time highs. For a cyclical business, that’s a warning flag for me.
All Shell’s previous share price peaks have come ahead of oil market crashes or recessions.
Is the outlook really so much better this time? I’m not convinced.
