Six short months ago, Royal Dutch Shell (LSE: RDSB) was the FTSE 100’s largest company. That place has now been taken by pharmaceutical group AstraZeneca, and the Shell share price is down by 40%.
Oil companies are out of fashion with investors. But although there are many arguments against these fossil fuel producers at the moment, I think it’s too soon to write them off. Here, I’ll explain why I see Shell as a contrarian buy and have topped up my holding since the market crash.
Why has Shell’s share price collapsed?
Shell faces a tough combination of short- and long-term problems at the moment. Right now, the company is battling with a slump in oil demand that’s been triggered by the coronavirus pandemic.
Looking further ahead, the oil industry is under increasing pressure to reduce its carbon footprint. Shell has made big promises to slash emissions and is aiming to become the world’s biggest electricity company by the 2030s. But the details of how this will be achieved are still very uncertain.
Even if Shell does succeed, we don’t yet know if the company will be able to maintain its current size and profitability in a greener world.
It’s a tough set of problems for CEO Ben van Beurden to solve. But he does have a few tricks up his sleeve which make me believe that Shell’s share price should rise again.
Don’t forget the big picture
I believe the world needs to address climate change urgently. But the reality is that billions of people all over the world still rely on fossil fuels for transportation, electricity, and the raw materials needed in manufacturing.
Despite this year’s oil price crash and demand slump, Shell is still expected to generate revenues of $236bn in 2020. The group’s profits are expected to drop to $3.3bn, but should recover to $9.5bn in 2021. That gives Shell shares a 2021 forecast price/earnings ratio of 12, which looks reasonable to me.
I’m pretty sure demand for oil and gas won’t disappear overnight. It’s also worth remembering Shell does a lot more than just pump oil and gas out of the ground.
The Anglo-Dutch group owns refineries, chemical plants, distribution networks and is a world-class energy trader. I believe many of these engineering and infrastructure assets will remain relevant in an electrified future, especially if LPG or hydrogen become more widely used as transport fuels.
Dividend cut should could help Shell shares
Shell’s share price fell when the group cut its dividend by 65% in April. It was a shock — the first cut by the company since the Second World War. But I’m certain it was the right thing to do.
The group’s $14bn annual dividend had become a burden which limited its ability to change and evolve. This isn’t right. Dividends should be paid from spare cash, when a business is operating as well as possible.
This cut will hit shareholders’ income this year (including mine), but I think we’ll benefit over the longer term. With the shares trading at around 1,300p and offering a yield of about 4%, I rate Shell as a long-term energy buy.