We live in strange and uncertain times. Not only has the coronavirus pandemic affected so many people’s health and lives, it has radically changed our lifestyles. Many of us now work from home and are unable to travel. As a result of this, and other issues such as the general oil glut, we saw negative oil prices last week, an unprecedented market situation. So should FTSE 100 investors buy oil companies now? And which firms should they buy? Well, the top UK companies in the field are Royal Dutch Shell (LSE: RDSB) and BP (LSE:BP).
Oil prices
First, I would say I agree with my Foolish colleague Matthew Dumigan on the prospect of the V-shaped recovery. Covid-19 quarantines must end at some point. European countries are slowly opening up some businesses, and the UK’s chief medical officer says the country has probably reached its peak in new Covid-19 cases. As a result, the demand for oil should recover.
Let’s be realistic — it won’t happen overnight. Yet negative oil prices are definitely not here to stay. So what do I think is the best approach to buying oil stocks? Investors planning to bet on these developments should choose the largest, most reliable companies, I feel. To me that means Royal Dutch Shell and BP, the largest (by far) on revenue.
Both shares are trading at multi-year lows, although this could change for better or for worse with Shell scheduled to report its first quarter results on the April 30 and BP on May 5. Earnings are expected to be much lower compared to the first quarter of 2019 due to the oil price weakness. But at the same time, the earnings announcements might be a wonderful opportunity to stockpile these shares.
Royal Dutch Shell
Credit rating agency Moody’s has affirmed Royal Dutch Shell’s Aa2 rating which is exceptionally high. However, the agency changed its outlook to negative due to a lot of uncertainty around Covid-19. The agency believes Shell management is right in planning $3bn-$4bn in cost cuts over the next 12 months. Moody’s also thinks cutting cash capital expenditure or fixed investments by $5bn would help. Importantly too, Shell has decided to suspend its buyback programme. This would obviously put some pressure on the company’s share price, but these measures should help the company work through the current oil price collapse. Its class A shares trade at the record low price-to-earnings (P/E) ratio of 7. The dividend yield is 11%.
BP
BP is facing a similar problem. However, Moody’s is slightly less optimistic about its financial position. The agency affirmed its A1 credit rating, also a good investment grade rating. Nevertheless, Moody’s main concern is BP’s rising debt level. At the end of 2019 BP’s adjusted debt was $97bn. This is about $20bn higher than before the last oil price fall in 2014/15.
On the other hand, the agency is optimistic given that BP has diversified, large-scale operations. This was partly helped by buying a 19.75% stake in PJSC Rosneft Oil Company. No company is too big to fail, but BP does come close. BP’s P/E ratio is just over 19, whereas its dividend yield is 10%.
Now what?
Given the pluses and minuses, I think that oil shares are good buys now. I’d prefer to buy Shell rather than BP because of Shell’s better financial position and lower P/E ratio.
