It’s not so long ago that the banks were in crisis and banking shares were at rock bottom, but a time of maximum pessimism is almost always the best time to buy shares. Granted, the banks have taken a few years to recover, but Barclays shares were selling for only around 60p in March 2009 and they’re worth 274p today!
Is the oil business at a similar stage now? With the crashing price of crude oil, the FTSE 100‘s big two are about as far out of favour as I can remember in my 30-year investing career. And they share a characteristic that the banks were not lucky enough to have — they’re fundamentally sound companies with no chance of going bust.
Share price slide
Look at BP (LSE: BP). At 380p, its share price is down 26% since the beginning of July 2014 — it did perk up a little in the first few months of this year as the Gulf of Mexico disaster retreated a little further into the past, but since May it’s been on the slide again. And things are pretty much the same at Royal Dutch Shell (LSE: RDSB), whose shares are down 27% since May 2014, to 1,879p.
The current fear, now that the tentative recovery in oil prices has reversed and Brent Crude is once again down below $50 a barrel, is that the price could slump a lot lower — some pessimists are even predicting $30! But how likely is that?
Well, the price seems to have stabilised a little over the past couple of weeks. But China is increasingly becoming the country to set price levels, and with OPEC production volumes at a high and Chinese growth slowing, we could indeed see further downward pressure. But that pressure will hit the smaller companies and those focused solely in areas of high production costs the hardest, and the big players like BP and Shell should be able to ride it out.
BP is on a forward P/E of 15.5, dropping to 12.5 based on 2016 forecasts (although some of those were based on slightly higher oil prices), with Shell on multiples of 14.5 and 12 for the respective two years. On those valuations, there’s surely not going to be much in the way of price recovery at today’s oil price.
Look at the cash
But for me the attraction right now is the juicy dividends, with forecasts suggesting 6.8% from BP and 6.3% from Shell this year, and similar levels in 2016.
The big question is whether such yields can be maintained, as they’d be barely (if at all) covered by forecast earnings. But both companies are committed to avoiding a cut, and have been cutting costs and shelving expensive operations to save cash for those all-important payouts. There obviously is a risk that they’ll have to swallow their pride and reduce the cash, but if they can manage to meet dividend forecasts for 2015 and 2016, I’d remain cautiously optimistic.
Recovery?
There will surely be a recovery in the oil price eventually, though BP chief Bob Dudley has suggested it could be another two or three years before it happens. We should then see a nice re-rating for BP and Shell. Trying to time it is a mug’s game, so my focus would be on the long term while enjoying 6% and more in cash per year in the meantime.
