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Why Tullow Oil plc and Royal Dutch Shell plc are bargain buys

This year has been hugely eventful for Tullow Oil (LSE: TLW). It has conducted a rights issue, changed its CEO as well as other senior management positions, and seen its share price decline by more than 30%. While this year may therefore be seen as a failure to some degree, the business now appears to be in a stronger position than for some time. Alongside Royal Dutch Shell (LSE: RDSB), Tullow Oil could be a top resources stock to buy right now.

Improving performance

Wednesday’s AGM statement from Tullow Oil did not present any particularly revealing information about the business. Key to its future is likely to be how quickly it can reduce leverage, and by how much production will rise following the completion of Project TEN. Both of these factors could act as positive catalysts on the company’s share price, and on both fronts the company seems to be making encouraging progress.

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In terms of debt reduction, Tullow Oil seems to be following an obvious path to improved performance. It is seeking to become a more sustainable and resilient oil producer at a time when the sector is experiencing fresh uncertainty. The $750m rights issue should go at least some way to solving its leverage issues, but further cost reductions and efficiencies will be necessary in order to improve the company’s balance sheet strength.

In addition to debt reduction, rises in production could also positively impact the company’s share price performance. As mentioned, Project TEN has been completed and this is forecast to significantly improve the company’s profitability. For example, earnings are due to return to positive territory this year and then record a rise of 61% next year.

Investment opportunity

Since Tullow Oil trades on a price-to-earnings growth (PEG) ratio of just 0.3, it seems to offer a wide margin of safety at the present time. However, within an Oil & Gas industry which has been severely devalued in recent months, larger and more diverse companies such as Shell also offer excellent value for money. For example, Shell has a PEG ratio of 0.4 and yet has a balance sheet which is already modestly leveraged, as well as cash flow that is strong.

Looking ahead, both stocks could experience a challenging period. The oil price may come under pressure if OPEC fails to extend its production cut beyond what is a relatively short space of time. And with demand growth continuing to be relatively sluggish, it would be unsurprising for oil to fail to rise significantly in future.

However, even given a difficult outlook, Shell and Tullow Oil could be worth buying. They offer bargain-basement valuations, upbeat growth potential and improving business models. Therefore, their share price falls since the start of the year seem unlikely to continue over the medium term.

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Peter Stephens owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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