Oil Falls To $100, But BP plc And Royal Dutch Shell Plc Are Still Buys

With concerns surrounding supply disruptions from Iraq receding, the price of oil has fallen to below $100 for the first time since May. Clearly, this is good news for motorists, but it means less profit for oil companies such as BP (LSE: BP) (NYSE: BP.US) and Shell (LSE: RDSB) (NYSE: RDS-B.US), since it has a negative impact on their revenues.

Despite this, both companies remain attractive at current levels and could prove to be winners in the long run. Here’s why.

Strong Yields

With inflation rising to 1.9% in June, the cost of living is back on the political agenda and with interest rates set to increase at only a modest pace, cash balances may struggle to keep up with inflation for a good while yet. Therefore, yields could be important both at present and over the next few years. On this front, Shell and BP do not disappoint, since they offer yields of 4.4% and 4.6% respectively.

Furthermore, there is scope for the yields of both companies to increase, since their dividend payout ratios are fairly low for mature companies operating in mature industries. For instance, BP’s payout ratio is just 49% and Shell’s is only slightly higher at 51%. Certainly, BP is going through a transitional period after the Deepwater Horizon tragedy in 2010, but both companies appear to have scope to be more generous when it comes to shareholder distributions.

Great Value

Although many stocks in the FTSE 100 and FTSE 250 are trading at relatively high valuations, oil stocks such as BP and Shell seem to have been left behind. That’s despite them having a strong first half of 2014, where shares in the two companies made gains of 11% (Shell) and 4% (BP). Indeed, they trade on price to earnings (P/E) ratios of just 11.5 (Shell) and 10.6 (BP), which highlights their good value at current levels when the FTSE 100 has a P/E of 13.9.

So, while the price of oil may cause some short-term weakness as the market reacts to a more stable situation in Iraq than previously anticipated, Shell and BP could prove to be strong long-term buys. Indeed, their mix of yield and value could prove to be a potent mixture.

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Peter Stephens owns shares in BP and Shell. The Motley Fool has no position in any of the shares mentioned.