Should investors seeking oil & gas sector bargains look at diversified major Royal Dutch Shell (LSE: RDSB), pure producer Tullow Oil (LSE: TLW) or services provider Petrofac (LSE: PFC)?
Shell’s £35bn takeover of BG Group was given the final green light on Friday when 99.5% of BG shareholders voted in favour of the deal, a sign of how much Shell overpaid. Although the deal was very expensive, it will help Shell in the short term by increasing free cash flow, necessary to maintain the 7.7% yielding dividend. Alongside significant downstream refining assets, Shell’s dividend is now well-positioned to survive at least two years of depressed crude prices.
While it’s impossible to predict when exactly the price of crude oil will bounce back, it isn’t a great stretch of the imagination to see crude prices returning to $60 p/b over the medium term, at which point the BG deal breaks even. Long term though, the deal represents a major bet on Shell’s part that the future of the company lies with Liquefied Natural Gas (LNG) rather than crude oil. Gas already accounts for over half of production and will hit 60% by 2020. Shell’s well-diversified portfolio, high dividend and low debt levels make it an interesting option for more risk-averse investors looking to dip their toes in the oil & gas market.
Too many ‘ifs’?
Unlike Shell, Tullow Oil has no major revenue streams other than pumping crude, so is much more dependent on prices rebounding soon. Share prices have seen a recent bump due to the Ghanaian TEN field coming on-line in July and a slight upswing in crude prices. While TEN is expected to double group profits, Tullow won’t make significant headway in paying down its $4.2bn mountain of debt as long as crude prices remain below estimated $38 to $45 p/b break even costs. Two significant ‘ifs’ remain for Tullow’s long-term outlook turning positive: crude prices skyrocketing and management proving it can clean up the balance sheet. While shares may bounce if crude quickly returns to anywhere near where it was in mid-2014, I believe there are better options out there for long-term investors.
Take a look
Share prices of oil services company Petrofac look set to rebound faster than either Shell’s or Tullow’s. Petrofac’s narrow focus on working with national oil companies in the Middle East and Africa has paid dividends as these companies continue pumping oil at record rates from their ageing oilfields. 2016 looks set to be a banner year for the company as order backlog has grown 14%, a disastrous off-shore project in the North Sea will finally be wrapped up, and profits are forecast to more than double to £320m. Petrofac’s valuation is also beginning to look downright cheap with the company trading at 8 times 2016 earnings and a 4.9% yield covered more than 2 times by earnings. With more upside potential than Shell and less downside than Tullow, I believe Petrofac may be a great option for long-term investors seeking exposure to the oil & gas sector.