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BP plc vs Royal Dutch Shell Plc: Which Oil Major Should You Buy?

Over the course of the last year, there has been only one winner when it comes to a head-to-head of BP (LSE: BP) (NYSE: BP.US) versus Shell (LSE: RDSB) (NYSE: RDS-B.US). That’s because, while Shell’s share price is up 1.5%, BP’s has fallen by 8.5%, with both of them being weaker than the wider index as a result of a declining oil price.

Looking ahead, though, is BP now much better value than Shell? Or, should you stick with Shell, since investor sentiment seems to be much stronger than for its sector peer?

Income Prospects

A key consideration for most investors considering the merits of BP and Shell is dividends. Certainly, yield matters but, with the price of oil having fallen so heavily, dividend sustainability has taken on a more important role. So, while BP easily beats Shell when it comes to dividend yields, with it having a yield of 5.7% versus 5.3% for Shell, its dividend coverage ratio is rather lacking relative to its peer.

That’s because, while Shell’s dividends are due to be covered 1.5 times by profit this year, the figure for BP is 1.3. Certainly, that does not mean that a dividend cut is likely for BP, but it does mean that it has less headroom when making dividend payments. So, if the oil price fall continues and profits spiral downwards, BP seems to be more likely than Shell to cut dividends.

Valuation

After a lacklustre year, both stocks offer excellent value for money – especially when you consider that the FTSE 100 has a price to earnings (P/E) ratio of 15.7. For example, BP has a P/E ratio of just 13.6, while Shell’s is even lower at only 12.2. So, while they both offer excellent value for money, Shell seems to be the pick of the two when it comes to value although, looking ahead, BP has the better growth forecasts.

For example, next year BP’s bottom line is expected to rise by 26% versus 9% for Shell. Again, both are highly appealing figures, but it could be argued that BP deserves its premium valuation versus Shell as a result of its better near-term prospects.

Potential Risks

Clearly, both companies have one major risk: continued falls in the price of oil. While for longer term investors this provides an opportunity to buy a slice of oil stocks at a very keen price, it does mean that short term share price falls cannot be ruled out. So, if oil does fall further, you may be able to buy BP and Shell at an even better price, although they are both highly appealing at the present time.

However, BP appears to have greater overall risk than Shell, owing to its larger exposure to Russia and the continued fallout from the Deepwater Horizon oil spill. Although Shell is undergoing a transitional period, its problems see rather minor when compared to BP and are much more internal rather than external, in so far as Shell has more control over the inefficiencies and scale problems that it faces than BP does over US regulators and the Russian economy.

As a result of this, as well as its greater headroom when making dividend payments and more appealing valuation, Shell seems to be a better buy than BP. Of course, both stocks are likely to deliver stunning share price performance in the long run and, if you are able to, buying both could be a very wise move.

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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.