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Why BP plc And Royal Dutch Shell Plc Are Stunning Buys Despite The Oil Price Collapse

With the price of oil falling to below $50 per barrel for the first time in almost six years, it’s understandable that investors in oil companies are feeling rather nervous at the present time. After all, a lower oil price means lower profit for the oil stocks, which has led to their share prices falling significantly over the last six months or so.

For example, the share prices of the two largest oil stocks listed in the UK, BP (LSE: BP) (NYSE: BP.US) and Shell (LSE: RDSB), have fallen dramatically over the last six months. BP’s shares are now 21% lower than they were in July, while shares in Shell have dropped by 13% over the same time period.

Valuation

Although seeing a share price fall so quickly in a relatively short space of time is somewhat worrying, it also creates a significant opportunity for longer-term investors. Certainly, the price of oil may fall even further, with production showing little sign of slowing down, but the valuations of oil companies such as BP and Shell are now pricing in even more dramatic falls that simply may not materialise.

For example, BP and Shell trade on price to earnings (P/E) ratios of just 10.7 and 11.3 respectively. While low on an absolute basis, relative to the FTSE 100 they appear offer even better value for money, since they represent a discount of 27% (BP) and 23% (Shell) to the wider index. As such, they offer tremendously wide margins of safety and so any uptick or even stabilisation in the price of oil could lead to a significant upward rerating moving forward.

Profitability

While a lower oil price does put the bottom lines of BP and Shell under pressure, both companies’ earnings are still forecast to be very healthy in the current year. For example, BP is expected to post earnings that are 15% below 2014’s figure, while for Shell the fall is set to be 10%. However, looking to 2016, both companies are due to post rises in profitability that somewhat make up for 2015’s anticipated falls, with BP’s earnings forecast to rise by 17% next year and Shell’s by 10%.

Looking Ahead

As a result of their healthy bottom lines, both BP and Shell can easily afford to make their anticipated shareholder payouts. And, with their shares being so lowly priced, they now yield a whopping 6.4% and 5.5% respectively. Such high yields could attract investor interest – especially with interest rate rises apparently on the back burner due to lower than expected inflation.

So, while there will inevitably be a number of lumps and bumps ahead for BP and Shell, with the oil price likely to fall further, they seem to make excellent long term buys. Their mix of value, income and (looking to 2016) upbeat growth prospects could be enough of a catalyst to boost investor sentiment and push their share prices higher.

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