Shell’s (LSE: SHEL) share price has lost 7% from its 13 May 12-month traded high of £29.56. This aligns with a similar fall in the oil price over the same time.
To me, this does not signal the start of a long bearish trend in the price of oil or Shell’s shares. Both resulted from short-term changes in supply and demand expectations that characterise this market. Most recently, this has been due to Chinese economic data, in my view.
How does China look now?
The country powered the prices of the commodities needed for its rapid economic expansion from the mid-1990s to the onset of Covid in late-2019. This included crude oil, of which it became the world’s largest importer in 2017.
However, its economy has struggled to rebound convincingly from the impact of the virus.
Q2’s growth rate of 4.7% year on year undershot forecasts of 5.1%. That said, its Q1 expansion of 5.3% beat expectations of 4.8%.
Last year, China targeted growth of around 5%, and it achieved 5.3%. It has the same target this year, which I also expect it to reach.
Also positive in my view was the 8.6% year-on-year rise in exports in June — the highest in 21 months.
What about the rest of the oil market?
Despite the recent fall, the oil price is still up over the year, driven by production cuts from OPEC+.
The cartel is currently reducing production by 5.86m barrels per day (bpd) – equating to around 5.7% of global demand.
This includes 2.2m bpd of cuts due to end in June, and 3.66m bpd due to expire at the end of this year.
However, its members – comprising the key Middle East oil producers and Russia – extended these cuts on 2 June to the end of September and the end of 2025 respectively.
Are the shares undervalued?
Against this backdrop, Shell’s shares look very good value to me.
It currently trades at 12.5 on the key price-to-earnings (P/E) stock valuation measure compared to its peers’ average of 13.9.
I ran a discounted cash flow analysis to work out how cheap they are in cash terms. This shows them to be 35% undervalued at their present price of £27.63.
So a fair value for the stock is £42.51, although it might never reach that figure and could even fall further from today, of course.
What are the firm’s growth prospects?
The share price could lose ground in the future from a sustained bearish run in the oil price. Another risk to it would be an environmental disaster due to one of the company’s drilling operations. This would be costly in cash and reputation terms.
As it stands though, analysts estimate that Shell’s earnings will grow by 5.8% a year to end-2026. Earnings per share are expected to increase by 9.5% to that point. And return on equity is forecast to be 12.6% by then.
I bought the shares at a much lower price, so am very happy with that position and do not intend to buy more. If I did not have it I would buy the stock now for its good growth prospects and its undervaluation. Positive for me as well is that it also currently delivers a dividend yield of 3.7%.
