Why Tullow Oil plc Can Be The Perfect Partner For Royal Dutch Shell Plc In Your Portfolio!

Tullow Oil plc (LON: TLW) and Royal Dutch Shell Plc (LON: RDSB) could make for a potent combination. Here’s why.

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oil rig

2014 just keeps getting worse for Tullow Oil (LSE: TLW). Indeed, today saw the announcement that the company has found non-commercial hydrocarbons at the Sputnik-1 well on its part-owned Arouwe block, which is located offshore of Gabon in West Africa.

As a result, shares in the company are down 4% on the day, which means that they have now fallen by a hugely disappointing 36% since the turn of the year.

This contrasts significantly with sector peer Shell (LSE: RDSB), which is flat for the year and has delivered encouraging news flow, which has helped it to outperform a wider index that has declined by 6% in 2014.

Differing Goals

Of course, Tullow Oil is generally expected to deliver a more volatile share price experience than Shell. After all, it is focused on oil exploration in high-risk areas that tend to be rather ‘hit or miss’. This means that, while some years turn out to be incredibly strong for the company’s bottom line and for its share price, others can prove to be the complete opposite.

This contrasts markedly with Shell. While it still has an exploration arm, Shell’s focus in recent years has been on diversification and stability. This means that its bottom line is far more consistent than that of Tullow Oil, but at the cost of a far less dynamic growth profile.

Growth Potential

Clearly, 2014 is proving to be a tough year for Tullow Oil and, as a result, the company’s bottom line is expected to fall by 12%. However, next year is set to be much better, with Tullow Oil’s earnings due to rise by a whopping 174%.

This may seem rather fanciful at first glance. After all, Tullow Oil is a FTSE 100 company and mega caps usually don’t grow earnings at that pace. However, when you consider that the company’s bottom line increased nine-fold in 2011, it’s clear that a 174% gain would be less unusual than at first glance.

Valuation

While Tullow Oil’s price to earnings (P/E) ratio of 53.3 may seem excessive, when it is combined with the aforementioned growth potential it shows that shares in the company offer growth at a very reasonable price. Indeed, Tullow Oil’s price to earnings growth (PEG) ratio is just 0.3, which is among the lowest in the FTSE 100 and indicates that share price growth could lie ahead for investors in the company.

Meanwhile, Shell also looks attractive based on its current valuation. Its increased focus on stability and consistency of course mean that earnings are set to grow by only 2% next year but, nevertheless, a P/E ratio of just 9.7 still shows that there is considerable potential for an upward rerating. Furthermore, a dividend yield of 5% adds even more appeal to the company moving forward.

Looking Ahead

So, while Tullow Oil is having a tough 2014, it still seems to have huge potential. Indeed, its considerable earnings and share price volatility could be tempered somewhat by holding it alongside Shell. The latter’s focus on consistency means that, while growth prospects may be slightly lacking, a top notch yield and low valuation, allied with Tullow’s superb growth potential, could prove to be a potent combination. As such, a partnership of Tullow Oil and Shell could be well-worth owning.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Tullow Oil. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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