Shell (LSE: SHEL) has been an unlikely stock market hero this year. Shell shares have risen by over 30% in 2022 and are 55% higher than they were one year ago.
I’ve profited from Shell’s recovery thanks to a small holding in my portfolio. But I’m starting to worry that we could see a sharp share price correction if energy prices moderate. Here’s what I’ve decided to do.
Getting back to normal?
Shell’s share price has now returned to levels last seen in 2019. At first glance, this might seem fair enough. Global oil and gas demand is pretty much back to pre-pandemic levels, after all.
However, Shell isn’t the same company it was before the pandemic. In 2021, Shell promised to start cutting oil production by 2% each year. The FTSE 100 group also said it would slash petrol and diesel production by 55% by 2030.
Alongside, this, Shell plans to step up spending on renewables and its retail operations. All of these changes are part of a plan to achieve net zero emissions by 2050.
I’m positive about these plans. I think Shell’s huge global retail and energy trading network is well positioned to support a switch to low emission fuels like hydrogen and electricity. But I’m not sure how these changes might affect long-term profits.
Profits could peak this year
Shell is expected to report record profits in 2022. But if energy prices stay this high, I think it’s pretty certain that the UK and many other countries will fall into recession.
That would probably cause oil and gas demand to fall. Prices would follow and Shell’s earnings would return to more normal levels.
In my view, chief executive Ben Van Beurden’s actions suggest that he also expects profits to fall. Since cutting Shell’s dividend in 2020, Van Beurden has kept Shell’s dividend at a fairly low level, relative to earnings.
Instead of paying out cash to shareholders, he’s pumping Shell’s spare cash into share buybacks — spending $8.5bn during the first half of 2022 alone.
Share buybacks reduce the number of shares in issue. This can provide a boost to future earnings per share, helping to offset falling profits.
Shell shares: what I’m doing
Shell is currently trading on less than six times 2022 forecast earnings. A low price-to-earnings ratio is a traditional value indicator, suggesting the shares could be cheap. If Shell can take advantage of its lower cost base to generate more stable profits, I think there could be an opportunity here.
However, broker forecasts suggest that Shell’s earnings may peak this year. I also think that the stock’s 3.7% dividend yield could put a limit on share price growth.
With interest rates rising and the risk of slowing growth, I reckon investors will want at least a 3.5% income from Shell shares. I know I do. That effectively caps the price for buying today at 2,400p.
On balance, think Shell looks fully priced today. I won’t be investing any more of my money in this business unless the shares become much cheaper.
I haven’t sold my Shell shares yet as I’m waiting to see how market conditions change over the summer. But my guess is that I probably will sell later this year.