With the oil price showing little sign of moving northwards, many investors are put off investing in the sector. Certainly, there is a very real possibility that demand for ‘black gold’ will fall in the short to medium term – especially if Chinese growth stutters. But, in the long run, the reality is that the current oil price of around $50 is simply unsustainable and is likely to rise.
As a result, it makes sense to have some exposure to the oil sector. However, there are a number of different options, in terms of buying an oil explorer, producer, or even services company. In reality, their valuations are all highly dependent upon the price of oil, with a rising price likely to improve investor sentiment, make new oil finds more economically viable, allow higher profit margins and also equate to greater capital expenditure, thereby benefitting services companies. Despite this, it makes sense to spread the risk among different types of oil companies, since they offer differing risk/reward opportunities.
For example, energy support services provider Cape (LSE: CIU) is set to post relatively strong results and not be hit as hard by the lower oil price as most oil sector peers. In fact, it is expected to post a fall in earnings of just 11% this year, followed by a fall of 1% next year. Given the horrific conditions in which Cape is currently trading in terms of capital expenditure and investment coming under real pressure, this would be an excellent result.
Furthermore, Cape currently trades on a very appealing valuation. It has a price to earnings (P/E) ratio of just 9.1, which indicates that its share price could move significantly higher. In addition, such a low rating equates to limited downside, since Cape appears to have a wide margin of safety. And, with a dividend yield of 5.8%, it remains a top notch income play, too.
Likewise, oil services company Amec Foster Wheeler (LSE: AMFW) is due to post relatively upbeat earnings figures for the next couple of years. Certainly, its bottom line is set to fall by 13% this year but, with growth of 4% being pencilled in for next year, investor sentiment could improve and start to reverse the 30% fall in the company’s share price that has taken place over the last year. That’s especially the case since Amec Foster Wheeler trades on a P/E ratio of just 10.9 and yields 5.5% from a dividend that is covered 1.7 times by profit.
Meanwhile, Shell (LSE: RDSB) is set to be hit much harder by the oil price fall. That’s at least partly because, as a major producer, its revenues are more closely linked to the price of oil and, as such, its bottom line is expected to decline by 32% in the current year. Clearly, this is hugely disappointing and is a key reason why Shell’s shares have performed so poorly during the course of 2015, with them being down 28% since the turn of the year.
However, Shell is expected to return to double-digit profit growth next year and, with it trading on a P/E ratio of 12, appears to be set for a substantial share price rise. And, while other oil producers may find their finances coming under pressure and investors may become worried about such issues, Shell has a very strong balance sheet that should allow it to endure the current low oil price environment and emerge in a relatively strong position. Therefore, it appears to be worth buying, alongside Amec Foster Wheeler and Cape, at the present time.
