VALUE INVESTING

Big Oil

By Stephen Bland (TMFPyad)
March 17, 2006

Two oil companies form the first and second largest shares in the FTSE100. BP (LSE: BP.) and Royal Dutch Shell (LSE: RDSB). Both of these offer value in the sense that they are cheaper than the market on several popular measures but let's see if there may be any mileage in them as short-term value plays. The following table shows some typical value data. P/E and yield are forecast, P/TBV and debt are historical as is P/S, being Price/Sales and P/CF being Price/Cashflow.

Company	Price	P/E	Yield	P/TBV	Debt	P/S	P/CF
BP	665p	11.5	3.25%	4.29	28.6%	0.98	11.7
Shell	1,853p	9.6	3.57%	3.02	7.0%	0.91	9.1

The FTSE100 is capitalised at a total of around £1,455bn at present so that BP at £136bn represents some 9.3% and Shell at £121bn represents 8.3% of the total index valuation. Together they make up 17.7%, a very substantial proportion for just two shares out of a hundred and both in the same business too.

The first four ratios in the table are my real loves, the pyad spread, whilst P/S and P/CF are not figures to which I normally pay too much attention though some value players may find them useful.

With this index on a P/E of about 13.0 and a yield of 3.1%, these two big oils are therefore a little cheaper than average on that basis. I don't know what the market P/TBV might be but these shares are no asset plays. Going further my guess is that they are not especially cheap on an asset view relative to the index either. Debt though is modest, especially Shell where it is almost non existent and thus very likely to be below average, a reasonable level of debt being the norm for most big companies.

What is immediately apparent from the data is that not only are these shares cheaper than the market but that Shell is cheaper than BP on every single count that I've shown, an interesting fact. Both are vast integrated oils and as far as I'm concerned you can't slip a fag paper's thickness between them in terms of differentiation. They are identical twins yet not identically rated twins.

I have no explanation for the different ratings and any attempt to find one would be overanalysing in my book as a value investor. I would add to this that speaking from memory, Shell has very frequently been in the situation of being cheaper than BP as long as I have been following the market.

I've written before that Shell can be attractive as a value play on a yield of 4% and it is not that far off it now. Frequently in its history during the time I have been following the market it has traded at as little as 2%. I recall when I set up HYP1 back in 2000, Shell's then yield was indeed around 2% but I included it for diversification as it is hard not to have at least one hole in the ground in an high yield portfolio, oil and other mining being in total such a massive proportion of the market.

As short-term value plays, both BP and Shell have declining eps forecasts unfortunately. Not ideally what the value investors seeks. Almost as important, with any mining share, there will be an emotional gearing of the share price to the price of their commodity. Both companies reported very strong rises in eps for the year to 31/12/05, assisted no doubt by the then rising price of oil. Where is oil going in future? I dunno but a popular view seems to be a fall over the next year or two and this I expect is where the declining eps picture has its origins amongst analysts. Do you buy this story? It's risky of course but it may be worth considering going against the popular view.

Shell in its guise as Royal Dutch B shares has come back a bit from the peak this year of over 2,000p. Whilst it hasn't reached my trigger point of a 4% forecast yield, which would occur at 1,654p under present dividend forecasts there may be some mileage in the shares for the patient.