While it has been a very challenging period for oil companies, with a lower oil price harming their bottom lines, now could be a great time to increase your exposure to the sector. Certainly, the level of supply has not been cut significantly and, with demand remaining relatively weak across the developing and developed world, there seems to be little chance for a sustained rise in the price of oil in the short run.
However, the longer-term outlook for the sector remains relatively upbeat, with oil producers such as Shell (LSE: RDSB) (NYSE: RDS-B.US) and Tullow (LSE: TLW) now offering very wide margins of safety. As such, their share prices could move significantly higher over the medium to long term.
A Logical Pairing
Of course, Shell and Tullow are very different companies, with Shell having highly diversified operations and stunning cash flow, while Tullow has more appealing growth potential, but arguably comes with greater risk. As such, the two companies, together, appear to be a logical approach for investors seeking to balance growth, income prospects, and value when increasing their exposure to the oil sector at the present time.
Income Prospects
While Shell’s bottom line is declining due to the lower oil price, it is still easily able to make its current level of dividend payments. For example, Shell is expected to have a dividend coverage ratio of 1.4 next year, which indicates that its dividend is sustainable, and also that there is scope for it to rise in the coming years. That, of course, is good news for the company’s investors, since Shell is already one of the most appealing income stocks in the FTSE 100, with it having a yield of 5.9% at the present time.
Growth Potential
Although Shell’s bottom line is expected to grow by 37% next year and is set to be boosted by the proposed takeover of BG over the medium term, Tullow has even better growth prospects. In fact, its earnings are all set to rise by an incredible 84% next year, as it transitions away from an exploration company and focuses more heavily on oil production. This, then, could be the catalyst to push Tullow’s share price significantly higher after a year in which it has fallen by 51% and dropped out of the FTSE 100.
Valuation
As mentioned, the oil sector currently offers investors a wide margin of safety, with further falls in the price of oil seemingly being priced in. As such, there is tremendous potential for capital gains, with Tullow’s price to earnings growth (PEG) ratio of 0.3 indicating that its shares offer excellent value for money at the present time. And, with Shell trading on a price to book (P/B) ratio of just 1.2, it seems to offer excellent value for money right now, too. As such, both companies could be set to soar over the medium to long term.
