The price of oil has jumped by 15% in the past four weeks and investors are now clamouring to get their hands on oil stocks to play this rebound.
However, picking the right stocks to achieve that, without exposing yourself to too much risk if the rally runs out of steam, is a difficult task. With this being the case, when picking oil stocks, it’s best to use a basket approach.
Basket strategy
Simply put, a basket approach involves using several different equities to play one theme — similar to diversification.
When it comes to oil, the best way to play a rebound in prices could be to use a basket of both a high-risk exploration and production company with a lower-risk, slow-and-steady oil giant. And when it comes to oil giants with a stable outlook, Shell (LSE: RDSB) meets all the criteria. Tullow Oil (LSE: TLW) could fit in as a high-risk exploration and production play.
Shell is one of the best slow-and-steady giants around. The company has paid a dividend since the end of the Second World War, and management is committed to ensuring that this record remains unbroken for the foreseeable future. Moreover, the company’s recent acquisition of smaller peer BG Group has helped establish the enlarged group as the largest liquefied natural gas trader in the world and while the level of debt taken on as part of the acquisition has concerned some investors, Shell’s management is looking to reduce the company’s gearing from around 25% back to a mid-teens level.
Asset sales will be the main lever Shell is going to pull to reduce debt and this should high-grade the company’s portfolio as Shell looks to sell off non-core, low-return assets to boost its cash pile. When the price of oil returns to more sustainable levels, this high grading will ensure that Shell’s profits recover faster.
Still, for the time being Shell’s shares are likely to languish until there’s a substantial increase in group profitability. But while investors wait for the company’s profit to recover, Shell’s shares support a dividend yield of 7.4%.
A transformational year
As Shell primes itself for growth, 2016 is also set to be a transformational year for Tullow. Indeed, the company’s eagerly awaited TEN project is set to start production in 2016 and should finally start to generate a return for the group after years of hefty capital spending on it.
As TEN comes online, City analysts expect Tullow’s pre-tax profit to hit around $52m this year and $200m for 2017, although these forecasts are likely to be revised higher as oil prices rise. The company currently trades at a forward P/E of 117, falling to 28.2 next year.
