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Why I’d Buy John Wood Group PLC And Petrofac Limited, But Would Sell Xcite Energy Limited

When it comes to investing, it seems to be that the longer your timeframe, the higher your returns. Of course, you must invest in the right companies, but if you can give your investments sufficient time to put their plans and strategies into action, then they can produce far better returns (when compounded) over a decade or two than they can over just six months or a year.

However, finding businesses that will still be around in the very long run is not an easy task. In fact, many stocks that are currently popular among investors may struggle to generate sufficient profitability or continue to refresh their products and strategy so as to keep up with customer demands, with new entrants coming along all of the time to better serve the changing tastes of consumers.

Clearly, the oil sector is different than most sectors. That’s because the product is homogenous (not taking into account the different types of oil, e.g. light crude, brent etc) and the price received is also uniform whichever company you may be. However, where oil sector companies can really establish an economic moat is with regard to their cost base and also the service that they offer.

Take, for example, Wood Group (LSE: WG) and Petrofac (LSE: PFC). They provide services to the oil industry and, as such, appear to be less dependent upon the price of oil in the short run. That’s because, while the amount spent on capital expenditure by oil producers is in decline, it is highly unlikely to fall for a prolonged period, since new investment is continually required so as to keep oil producers in business.

As such, Petrofac and Wood Group are expected to post earnings in 2016 that are only 5% and 10% respectively below their 2014 figures, which indicates that even with such a major fall in the price of oil over the last year, they have sufficient economic moats to ensure that their financial performance is not hit as hard as that of oil producers.

Clearly, though, a number of oil producers are worth buying at the present time. However, for oil explorers such as Xcite Energy (LSE: XEL), which is not expected to begin production for a number of years, the short to medium term is set to be rather challenging. And, with regard to economic moats, Xcite Energy appears to offer a relatively small one due to its regional exposure.

Certainly, the Bentley field is a great asset when the oil price is relatively high, but at less than $60 per barrel, it is not as economically appealing or as viable as prospects outside of the North Sea. That’s simply because North Sea oil costs are relatively high and push Xcite Energy’s cost base northwards, thereby providing it with a reduced economic moat and, ultimately, less scope for generous profits – especially while the oil price is low.

As such, it appears to be worth avoiding for now, while the likes of Wood Group and Petrofac continue to offer the prospect of comparatively consistent performance due to their relatively generous economic moats.

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Peter Stephens owns shares of Petrofac. The Motley Fool UK owns shares of Petrofac. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.