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Shell downgraded by Morningstar

James Gard  |  28 Jun 2021Text size  Decrease  Increase  |  
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Oil giant Shell (RDSA) has been downgraded and stripped of its economic moat by Morningstar analysts, who blamed the ESG uncertainty overhanging the sector and lower expectations for oil prices over the next decade.

The FTSE 100 company now has no economic moat and its fair value estimate has been lowered from £2200 per share to £1940 per share. The company closed Friday at £1494, a 23 per cent discount to the new fair value.

The stock was the first in a new video series on undervalued UK stocks. Last year it cut its dividend for the first time since the second world war as oil prices plunged, and this had a big impact on income seekers. Since then the oil price has rebounded sharply as people get back in their cars again, and the company has proposed an increase to its dividend.

Oil analyst Allen Good explains the thinking behind the downgrade:

“We have downgraded Shell’s economic moat rating to none from narrow as our forecast for excess returns has become too low while the company’s future uncertainty is too high to award a moat. The downgrade of the moat rating might appear to be a quick reversal from our upgrade to narrow a few years ago.

“At the time, integrated oils, including Shell, had made significant headway in reducing operating costs in their existing production base and capital intensity of new projects so we forecast they could earn adequate excess returns at our midcycle price assumption of $60/bbl.

“While Shell has managed to maintain those improvements, the uncertainty of excess returns 10 years from now has increased due the changing composition of the business and potential level of commodity prices. In short, we have neither the confidence that Shell’s plan to transition to a more renewable and low-carbon business will create competitive advantages nor that commodity prices will consistently be at levels sufficient to generate excess returns during the next 10 years.

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“As such, Shell fails to meet key criteria of our narrow economic moat rating. As time passes and Shell demonstrates a high level of competence and execution in these newer areas or our view changes on commodity prices, we could revise our moat rating.

“The moat downgrade negatively affects our valuation, but is partially offset by higher oil prices since our last update, resulting in a 7% decline in our fair value estimate. Shares still appear cheap at a discount of nearly 25%. However, given a lower yield and less oil exposure, Shell might lag in an oil price rally.”

is senior editor for Morningstar.co.uk

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