Why I’d Buy Royal Dutch Shell Plc But Sell Gulf Keystone Petroleum Limited

Shell (LSE: RDSB) (NYSE: RDS-B.US) has been in the headlines recently following its £47bn takeover attempt for BG. The combined entity will have a hugely diversified and high quality asset base that is likely to lead to greater efficiencies and synergies, thereby lowering Shell’s cost curve and improving its long term earnings growth outlook. And, while it may take time to come good, the deal appears to be a good one for investors in Shell (as well as BG).

Financial Standing

Of course, the major reason why Shell can pull off such a major acquisition is its financial standing. Shell has always had a modestly leveraged balance sheet with, for example, its debt to equity ratio standing at just 27% as at the end of 2014. This provides it with tremendous scope to make not only an acquisition the size of the proposed deal with BG (i.e. a major one) but also make others, too. And, with the energy sector trading at a very low ebb at the moment, Shell could take part in further M&A activity within the sector and secure highly lucrative assets at a fraction of their intrinsic value.

Great Value

With Shell forecast to increase its bottom line by an impressive 34% next year, its price to earnings (P/E) ratio of 16.1 appears to be unjustifiably low. And, on the topic of valuation, Shell’s price to book (P/B) ratio indicates that a substantial upward rerating could be set to take place over the medium to long term, since Shell trades below net asset value, with it having a P/B ratio of just 0.8. So, while its share price has disappointed in recent years (it is up just 12% in the last five years), that could all be about to change moving forward.

A Smaller Peer

The investment opportunity with Shell differs markedly with that of Gulf Keystone Petroleum (LSE: GKP) (NASDAQOTH: GFKSY.US). For starters, they are of very different sizes, while Gulf Keystone lacks the diversity, financial standing and future prospects of Shell. Furthermore, its short term future continues to look rather doubtful, with a lack of clarity regarding cash payments from the Kurdistan Regional Government (KRG) causing it to cease exporting oil and focus on domestic sales, which provide it with a substantially lower price.

And, with the political situation in Iraq/Kurdistan being very volatile and highly uncertain at the present time, investing in Gulf Keystone Petroleum does not appear to be a logical move – especially since investor sentiment continues to worsen on a weekly basis. In fact, shares in the company are now down 43% since the turn of the year.

As such, and while there is a tremendous opportunity to invest for long term growth with Shell, Gulf Keystone Petroleum does not appear to be a worthwhile investment at the present time, with it being too risky for the potential rewards on offer.

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Peter Stephens owns shares of 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.