Royal Dutch Shell Plc: Next Stop £25?

At the start of 2016, few investors would have thought that just 12 weeks down the line Shell’s (LSE: RDSB) share price would have risen by around 10%. That’s at least partly because in 2015 Shell was a desperately poor performer, with its shares slumping by a dismal 31% in the calendar year and showing little, if any, sign of a recovery.

Today however, many investors are feeling rather optimistic about Shell’s progress and this is reflected in its rising share price.

Clearly, some of this is due to a higher oil price with it now selling for around $40 per barrel rather than the $30 per barrel at the start of the year. Looking ahead, this trend could easily continue for a good while yet since even at $40 per barrel, a number of oil producers are relatively unprofitable. Therefore, in the long run the current level is rather uneconomic and a reduction in supply could be the end result, which would have a positive impact on the oil price.

Strong strategy

Allied to a rising oil price, Shell’s strategy also now seems to make more sense to investors. While it has come under a degree of criticism for its purchase of BG, as well as changes being made to exploration spend and investment, Shell’s approach to a depressed oil price environment appears to be spot on. In other words, it has reduced non-essential spending and made use of its strong cash flow and sound balance sheet to buy assets at discounted prices.

With Shell having huge financial firepower, further M&A activity could be on the cards and this could act as a positive catalyst on its share price. And with the company’s efficiencies having scope to improve, its competitiveness may also increase versus its sector peers. This could be a key differentiator for Shell compared to those peers, since while many of them are seeking to simply survive the current period, Shell is thinking long term and attempting to benefit from it.

Focusing on its current valuation, Shell has a price-to-book-value (P/B) ratio of around 1.2 and seems to offer good value for money. For its shares to reach £25, its P/B ratio would need to rise to around 1.8 and while that does represent a major increase, it’s nevertheless very achievable over the medium-to-long term. That’s because Shell is still hugely profitable and if its bottom line continues to remain so, then a rising oil price could convince investors it’s worthy of a substantially higher valuation.

Clearly, between now and then Shell’s share price is likely to remain highly volatile. Although the long-term prospects for oil are reasonably positive, recent months have shown that it can produce unexpected price movements in the short run. But for investors who can live with such uncertainty, Shell’s current price indicates that it’s an excellent buy. It has the right strategy, healthy finances and could continue its recent gains to reach £25 per share over the medium-to-long term.

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Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.