Investment bank Morgan Stanley has reiterated its 'overweight' rating on Royal Dutch Shell (RDSB) and raised its price target from £26.00 to £27.50.
BIG UPSIDE
At the current share price of £22.82 this implies upside of more than 20%. Central to the bullish view is an increase in free cash flow (FCF) boosting confidence in the dividend and driving the yield towards its historic average.
Morgan Stanley's number crunchers note that consensus estimates for Shell's rolling 12-month forward FCF have improved substantially, from $7bn in April 2016 to $17bn today. This would cover the $16bn of dividends pencilled in. The first time in four years that consensus forecasts a fully covered dividend.
While Shell's yield has come down from 7.5% to more like 6.8% it is still some way off its historic average of 1.5-times the yield offered by the wider market. This would imply a yield of 5.5% which in turn informs the £27.50 price target.
MAJOR CONCERNS
The analysts note two major concerns among investors, the ability of the company to actually delivered the forecast FCF and worries over the level of indebtedness.
They comment: 'FCF generation in 2017/18 should be materially higher due to higher oil prices, ramp-up of key projects such as Gorgon, Lula and Kashagan,and lower costs, both capex and opex. 'Also, we believe Shell could achieve the half-way mark of its $30bn asset disposal target in 2H17, with the full $30bn to be reached during 2018.'
