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3 Reasons To Buy BP plc And Royal Dutch Shell Plc

Together, BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) account for more than 12% of the FTSE 100 and these two corporate giants deserve a place in every investor’s portfolio. 

However, over the past 12 months, Shell and BP have underperformed the FTSE 100 by 27% and 15% respectively excluding dividends. 

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So, here are three reasons why investors should continue to buy Shell and BP despite their lacklustre performance. 

Valuation

BP and Shell have a reputation for being two of the UK’s most trustworthy income stocks. Shell has paid and raised its dividend every year since the Second World War. Similarly, BP was one of the most widely held income stocks by portfolio managers until it cut its dividend following the 2010 Gulf of Mexico disaster. 

BP is now working hard to restore its dividend reputation and is set to yield 6% this year. The payout will only just be covered by earnings per share this year. Next year the payout cover is set to increase to 1.3x. 

Shell’s dividend yield has recently surged to 6.5%, and the payout is covered one-and-a-half times by earnings per share. 

Key advantage 

Integrated oil companies like Shell and BP have one huge advantage over their smaller, pure E&P peers. You see, as well as producing oil, Shell and BP both refine and process oil, a business that benefits from a low oil price. 

For example, BP’s underlying pre-tax replacement cost profit from downstream (refining and processing) activities in the first quarter of 2015 more than doubled to $2.2bn  At the same time, pre-tax profits from oil and gas production, or upstream, collapsed to $0.6 billion from $4.4 billion a year earlier.

Shell’s first quarter refining and marketing profits jumped 68% to $2.6bn. Downstream profits fell 52% to $3.2bn. Shell and France’s Total are the world’s largest oil traders, handling enough fuel every day to meet the needs of Japan, India, Germany, France, Italy, Spain, and the Netherlands. 

Clearly, higher profits from refining and marketing arms won’t completely offset declining upstream income, but they do go some way to cushioning the effect of low oil prices. Further, at a time when many other producers are struggling to make ends meet, upstream operations give Shell and BP a robust and predictable income stream with which to finance deals and pay dividends. 

Clean balance sheet 

The third reason Shell and BP are great investments is the fiscal prudence they exhibit. Specifically, both Shell and BP have rock solid balance sheets with low levels of gearing and healthy cash balances. What’s more, the two companies are currently in the process of pruning their asset portfolios, to free up cash from underperforming assets. 

At the end of the first quarter Shell’s net gearing, calculated by dividing its net liabilities by stockholders’ equity, stood at 14%. The deal to buy BG Group will push this figure higher, but Shell is planning to sell off $30bn worth of assets over the next few years to fund the transaction. At the end of the first quarter, BP had over $30bn of cash on its balance sheet and a net gearing ratio of 23%.

A high percentage of BP’s cash is reserved for the company’s legal liabilities stemming from the Gulf of Mexico disaster. Although, as the lion’s share ($18bn) of these liabilities set to be spread out over the next 18 years, BP’s cash isn’t going to disappear overnight. 

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Rupert Hargreaves owns shares of Royal Dutch Shell B. 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.