Energy stocks head to head: Royal Dutch Shell plc and Petrofac Limited

Which of these two oil stocks should you buy for income and growth: Royal Dutch Shell plc (LON:RDSB) or Petrofac Limited (LON:PFC)?

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Energy stocks are among this week’s biggest fallers as crude oil prices slide further on renewed supply glut fears. Shares in Royal Dutch Shell (LSE: RDSB) are currently 4% below where they were trading last Friday, while shares in Petrofac (LSE: PFC) have fallen by 5.1%.

The profitability of both these companies clearly depends on the price of oil, and their recent share price performances reflect their similarities. However, these two companies are far from being identical. Shell is a £146bn integrated oil & gas major, while oilfield services company Petrofac has a market capitalisation of just £2.8bn.

The risks and rewards for both stocks are also quite different, as are their underlying sector fundamentals. Below, we will take a look at some of the similarities and differences between both companies to determine which stock makes a better investment.

Petrofac

Although weak energy prices don’t directly lead to lower profits for oilfield service companies, they’re nonetheless affected by volatility in the commodity’s price. That’s because lower oil prices force producers to cut investment in drilling new wells, causing oil service and equipment revenues to fall and margins to compress.

But Petrofac has been shielded from the worst of the cuts because of its heavy focus on the Middle East. Keen to protect their market share and take advantage of their relatively low production costs, producers in the region, particularly sovereign oil companies, have either maintained or increased their oil spending.

This helped to lift Petrofac’s revenues for the first half of 2016 by 22%, to $3.89bn, and the company is back in the black with a profit of $12m. Its order backlog did shrink somewhat though, but is still worth $17.4bn, which equates to around two-and-a-half years of revenues.

Shell

Shell, on the other hand, has fewer places to hide. While it can shift its focus to operations that have held up better, by boosting LNG capacity and cutting back on high-cost production, its global scale and diversification mean this has a relatively small impact on its overall earnings. So revenues in H1 2016 fell by 23%, while underlying CCS profits were 89% lower, at $1.05bn.

And although its downstream operations have acted as a cushion against weak upstream profits, refining margins have lately come under pressure from increased competition. So unless oil prices bounce back strongly soon, earnings could have a lot further to fall.

Valuations and dividends

Shell is the more expensive stock, with a forward P/E of 26.1, based on city forecasts of earnings per share (EPS) for 2016 of 74.3p. This compares unfavourably to Petrofac, which thanks to a bullish outlook on Middle East oil spending, has a forward P/E of just 11.6.

On an income perspective, both stocks offer generous dividends. Shell has the higher dividend yield – 7.8% compared with Petrofac’s 6.1% – but its dividend isn’t fully covered. Shell’s forecast dividend cover for 2016 is a mere 0.5 times and the consensus forecasts show city analysts don’t expect earnings to fully cover dividends for at least another two years.

Meanwhile, Petrofac’s underlying dividend cover is forecast to exceed 1.4 times in 2016 and 1.8 times by 2017. For me, this combined with its valuations make Petrofac the more attractive stock right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jack Tang has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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