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Why Is Royal Dutch Shell Plc So Cheap?

Having a wander round the FTSE 100 and looking at a few fundamental figures, it’s surprising what anomalies can crop up.

Well, I think Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) trading on a forward P/E as low as 11 is an anomaly, at least. After all, it’s one of the biggest companies supplying one of our most essential needs — but it can’t even command a valuation in line with the FTSE’s long-term average P/E of 14.

Price is heading up

royal dutch shellAnd that’s even after a share price rise of 12% over the past 12 months to 2,466p, beating the 8% achieved by the FTSE 100 and with significantly better dividends — Shell has been yielding 4.7% compared to around 3% for the index average. So what gives?

Well, 2013 saw a fall of nearly 40% in earnings per share (EPS), with Shell putting the damage essentially down to “higher depreciation, increased exploration expenses, lower upstream volumes and weak industry conditions in downstream oil products“.

Perhaps surprisingly, the price only took a small dip before recovering strongly.

And although first-quarter results to April showed more of the same tough markets, chief executive Ben van Beurden did tell us the company is aiming for “better financial performance, enhanced capital efficiency […] and continuing strong project delivery“.

Forecasts bright

Forecasts for the coming year have been erratic, with a fairly wide spread between individual analysts. But there’s a consensus for around 220p EPS for this year, and that would represent a recovery of more than a third from 2013’s figure.

Looking further ahead, the City is expecting steady earnings progress with Shell’s dividend rises set to continue. And that should be underpinned by a target of improved capital efficiency — the firm is divesting itself of underperforming downstream assets.

Cash while you wait

All of this together makes me feel that Shell has genuinely had problems, but the recovery from them looks solid — and sentiment has yet to catch up with the company’s strengthening prospects. That makes the shares cheap, as far as I’m concerned, especially with Shell’s commitment to strong dividends — if you buy at today’s prices, you’d get dividends in excess of 4.5% while you’re waiting for share price appreciation.

But that’s me — you, of course, have to make your own decision.

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Alan does not own any shares in Royal Dutch Shell or Tesco. The Motley Fool owns shares in Tesco.