Royal Dutch Shell Plc vs BHP Billiton plc: Which Resources Major Is The Best Buy?

If you could only buy either Royal Dutch Shell Plc (LON: RDSB) or BHP Billiton plc (LON: BLT), which should it be?

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Suffice to say, the last year has been a challenging one for investors in Shell (LSE: RDSB) (NYSE: RDS-B.US) and BHP Billiton (LSE: BLT) (NYSE: BBL.US). That’s because, with commodity prices having fallen sharply, their profitability has come under pressure and, with investor sentiment also weaker, their share prices have fallen by 22% and 30% respectively during the period.

Looking ahead, though, is now the right time to buy either stock? And, if so, which one has the best prospects for capital growth and an income return?

Growth Potential

With the price of oil, iron ore and other commodities set to remain low over the short to medium term, the prospects for earnings growth in the current year are understandably limited. As such, both Shell and BHP are forecast to post a severe decline in their bottom lines this year, as the full impact of the global supply/demand imbalance is felt. For example, Shell’s bottom line is expected to decline by 34%, while BHP’s earnings are due to be 44% lower than they were last year.

However, next year sees the two stocks offer differing earnings profiles. While BHP’s bottom line is expected to fall by 23%, Shell is due to post a rise in net profit of 28%. Clearly, this could prove to be an optimistic forecast, but with cost cutting, its strategy of selling off non-core assets and further efficiencies likely to have a positive impact on its profitability, Shell could buck the trend and turn around a difficult 2015.

Valuation

While neither stock is the cheapest in its respective sector, that is for good reason. After all, both Shell and BHP have excellent cash flow, very strong balance sheets, and relatively low cost curves for their industries. Therefore, while there is a good chance that a number of smaller operators within the resources sector will fail, Shell and BHP are likely to ride out the current weakness in commodity prices, and could emerge even stronger on a relative basis.

As such, neither stock is the cheapest in its sector, but on the valuation front Shell offers much greater potential for an upward rerating than BHP. That’s because Shell trades on a price to earnings (P/E) ratio of just 14.6 and, with its bottom line set to grow next year, this equates to a price to earnings growth (PEG) ratio of just 0.4. This indicates growth at a reasonable price, with a relatively large margin of safety being included in Shell’s valuation. Meanwhile, BHP has a P/E ratio of 14.1 but, with its net profit set to fall next year, it is expected to trade on a P/E ratio of 18.3, which is much higher than the FTSE 100’s P/E ratio of around 16.

Income Prospects

While the share price falls of both stocks have caused their yields to rise, Shell continues to offer a greater yield than BHP. For example, Shell currently has a yield of 6.4%, with BHP’s yield being a still very appealing 6.1%.

Both of these figures are much higher than the FTSE 100’s yield of around 3.5%, but Shell’s earnings growth potential marks it out as a more sustainable dividend play. For example, Shell is expected to cover dividends 1.4 times with net profit next year, while BHP is forecast to pay out more in dividends than it generates in profit in 2016. Clearly, this situation is not sustainable in the long run for BHP and, as such, a dividend cut or improved profitability are required in the medium to long term.

Looking Ahead

So, while BHP remains a top quality stock with a sound long term future, Shell has an improved short to medium term outlook. In fact, Shell offers a higher yield, more sustainable dividend, lower valuation and improved growth prospects than BHP and, as such, if you can only buy one or the other then Shell looks to be the more appealing of the two companies at the present time.

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 BHP Billiton and Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. 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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