Is the Royal Dutch Shell share price heading for 3,500p?

If you had been lucky enough to buy shares in Royal Dutch Shell(LSE: RDSB) on the 10th of January 2016, today you would be sitting on capital gains of 82%.

Including dividends, investors have received the total return of 110% over this period, making Shell one of the best-performing stocks in the FTSE 100, outperforming the broader index by more than 80%.

After these gains, it might seem as if shares in this oil giant have run out of steam. But I believe they still have plenty more in the tank. Here’s why.

Different business

If you look at a Shell stock chart going back to the year 2000, you will see that the highest price the stock has achieved is 2,800p (March 2018) surpassing the previous high of 2,572p reached in November 2014, just before the price of oil collapsed.

I believe the reason why the share price printed a new all-time high this year is that Shell today is a fundamentally different business than it was in 2014. Over the past two-and-a-half years, the company has been on an intensive rehabilitation programme. Costs have been slashed, and all projects have been re-evaluated, so that every single dollar spent is now spent effectively. Management has tried to eliminate almost all waste in the business’s budgets, and this is now paying off.

At the beginning of November, the company reported a 35% increase in its third-quarter earnings. Earnings on a current cost of supply basis hit $5.6bn in the three months to September 30. Based on the firm’s results for the first nine months of 2018, analysts believe the group is on track to report the total net profit for the year of $23.5bn, on revenues of $392bn.

By comparing the above numbers to those of 2013/2014, when the price of oil was around $100 a barrel, we can see just how far the company has come over the past three years. In 2013, the group reported revenues of $451bn, but a net profit of only $16.3bn. In 2014, it booked a net profit of $15bn, on sales of $412bn.

In other words, the company is generating nearly 100% more profit for every $1 of sales it achieves today, compared to 2013, even though the price of oil is still around 40% lower.

Earnings surge

These numbers tell me that if the price of oil does return to $100 a barrel, Shell’s earnings could surge, which would justify a significantly higher share price.

How much higher can it go? Well, according to City analysts, Shell is expected to report a net profit margin of approximately 7% in 2019. I’m assuming that if the price of oil returns to $100 a barrel, Shell’s revenue will move back up to $451bn. A profit margin of 7% on this figure implies a net profit of around $32bn, or $3.80 per share (290p). These numbers exclude the impact any share repurchases might have on the number of shares outstanding.

Historically, shares in Shell have changed hands at an average P/E of around 12.12 times projected earnings per share of 290p and implies a potential share price of 3,480p.

So overall, my figures show that if the price of oil continues to move higher, shares in Shell could add a further 42% from current levels, and that’s excluding dividend payments. With these gains still on offer, I’m a buyer of the stock today.

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Rupert Hargreaves owns shares in Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.