Shell's Financial Outlook Warrants Hold Rating Amid Rising Debt, Trading Vulnerabilities, and Unjustified Valuation Premium

HSBC analyst Kim Fustier downgraded Shell to a Hold rating, citing rising net debt, increased reliance on trading, and an unjustified valuation premium. Shell's net debt is expected to rise by nearly 50% in coming years, and its trading profits are projected to decline. Shell's valuation premium over peer Total is deemed unjustified, contributing to a cautious outlook.

Title: HSBC Downgrades Shell to Hold, Citing Rising Debt and Declining Trading Profits

HSBC analyst Kim Fustier has downgraded Shell Plc to a "hold" rating, reflecting concerns over the company's rising net debt, weakening trading profits, and an unjustified valuation premium. The downgrade comes as Shell's net debt is projected to increase by nearly 50% by 2027, driven by cash shortfalls and increased capital expenditures. The analyst also noted that Shell's trading earnings, particularly in the Integrated Gas segment, are under pressure as energy markets normalize. Shell's earnings from trading make up an estimated 25% of post-tax income, compared to 20% at BP (NYSE:BP) and 10–15% at TotalEnergies (EPA:TTEF).

HSBC expects Shell's return on average capital employed (ROACE) from trading to be around 2%, which is at the bottom of Shell's 2-4% guidance range and in line with the 10-year average. The Integrated Gas NOPAT forecasts for 2025-2027 were cut to 12% below consensus. Additionally, Shell's valuation premium over TotalEnergies is under scrutiny. The company trades at a 10–15% premium on 2026 EV/DACF and P/CF multiples, despite a lower 2026 distribution yield of about 11% versus Total's 13%.

HSBC has reduced Shell's 2025–2027 net income and cash flow estimates by 4% and 5%, respectively, reflecting weaker trading and deeper losses in Chemicals, only partly offset by stronger Upstream and Marketing performance. The firm maintains its $3.5 billion quarterly buyback for Q3, but the projected payout ratio will rise to 51-52% over 2025-2027, breaching Shell’s stated 40-50% range. Shell does not currently have a fixed gearing target, unlike peers.

Lease payments, revised to $5bn annually, reduce Shell’s 2026 free cash flow yield to 6.3%, versus 8.7% before leases, creating a funding gap of over $9bn, or 4% of market capitalization. Disposals are unlikely to bridge this gap alone, based on recent divestment trends.

Shell's dividend history, stretching back to World War II, was interrupted by a pandemic-driven oil price collapse in 2020, highlighting the risks of dividend traps. Investors should be cautious about companies with high payout ratios, narrow economic moats, and poor Distance to Default scores, as these factors are predictive of dividend cuts.

[1] https://www.investing.com/news/stock-market-news/hsbc-downgrades-shell-to-hold-on-debt-concerns-fading-trading-profits-4167412
[2] https://global.morningstar.com/en-ca/stocks/not-all-dividend-stocks-are-safe-heres-how-avoid-dividend-traps