The Daily Telegraph
The oil price is saying one thing but oil shares are saying another. So hold Shell
Gushing cash and looking cheap, normally we’d worry that Shell was too good to be true. Russ Mould explains why it’s still worth holding
Normally this column would run a mile (or at least take profits) when a company’s profits are booming, cash-flow is gushing and the stock looks amazingly cheap on a forecast price-to-earnings ratio of less than five times, a figure that is only a fraction higher than the dividend yield.
After all, this all screams of a scenario where everything is just going so well that it can hardly get better. And, to use the sometimes perverse logic of financial markets, if things cannot get better then at some stage they are going to get worse, and if they are going to get worse the share price will sniff it out. And if that is the case, it is time to lock in any gains now and move on before anyone else does.
In the case of Shell, however, this column
will make an exception and stay firmly put. In doing so we maintain our exposure to oil through this giant company as well as via the up-and-coming producer i3 Energy and the oil equipment and services play Hunting, covered here a week ago. Frankly, it is tempting to take a look at BP, too, especially as BP now offers a higher dividend yield than Shell, of some 4.6pc, but we digress.
This is because sentiment does not feel bullish on oil or oil stocks. The price of crude oil has fallen by a quarter since its March peak of $128. There are rumours that Shell’s chief executive, Ben van Beurden, is thinking of stepping aside next year. The G7 group of leading economies has imposed a price cap on (Russian) oil, while windfall taxes are in place and further such levies cannot be ruled out.
As a result of these three factors, Shell’s share price is no higher now than just before coronavirus swept around the globe in early 2020, despite the subsequent surge in oil and gas price and the company’s profits.
Yes, the dividend is lower now than it was then, and North Sea taxes are higher. But the lowly valuation multiple attributed to Shell’s earnings by the investors is still implicitly saying that oil and gas price strength is not going to last, or that if it does then government action in the form of taxes or price controls will weigh on profits and cash flow anyway. Such arguments can be countered. First, demand for energy continues to rise but supply remains constrained, thanks to environmental policies, geopolitical sanctions and oil companies’ response to pressure not to drill. This feels like a recipe for a rising price.
Second, windfall taxes and price controls have a very poor record of achieving their goals. The American president Richard Nixon imposed price controls on oil in 1971 and one of his successors, Jimmy Carter, added a windfall profits tax in 1980.
The 1970s were wracked by higher energy prices and it can be argued that cheaper energy ushered in a new era of prosperity only in the 1980s after Carter’s successor, Ronald Reagan, scrapped both the price controls, in 1981, and the windfall tax, in 1988. Additional legislation to provide tax breaks and incentivise higher output did the rest.
Finally, share price movements look telling. Now the market cannot be right all of the time, or no one would ever make any money, but its views must be respected. And right now, oil shares are performing remarkably well, given the circumstances.
Markets are trying to convince themselves that America’s headline inflation figure of 9.1pc for June is the peak and that its central bank, the Federal Reserve, can start to loosen monetary policy next year, especially as July’s reading was 8.5pc. Since July 13 and the publication of that “peak” inflation figure, the price of Brent crude oil has fallen by 5pc.
But global oil shares have risen by 14pc and shares in global oil equipment and services companies have gained 11pc, using two Us-quoted tracker funds as benchmarks, namely the Energy Select Sector SPDR fund and the ishares US Oil Equipment & Services ETF.
Oil may be saying one thing but oil stocks are saying another and the louder the latter speak the more attention investors may have to pay.
Questor will stick with Shell. Hold.