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Why 2018 should be a great year for BP plc and Royal Dutch Shell plc

The oil business has been through a torrid time with the price of a barrel fetching under $30 in early 2016 before recovering to today’s $55+ levels.

BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) are far too big to come under the level of pressure that raised fears of smaller oil explorers going to the wall, but they both ended up selling off billions in assets in order to keep their debts under control and the cash flowing.

Slashing the cash?

The big fear for investors was that dividends might have to be cut, but BP famously said it had no plans to do so, with chief executive Bob Dudley predicting that the tough times were likely to last at least a few years.

BP has been good to its word, though it hasn’t seen its dividends covered by earnings since 2013 — and forecasts suggest only marginal cover by 2018. But I’d be shocked to see a dividend cut at this late stage — and I’m pretty confident that forecasts for yields of 5.9% are likely to be met.

For its part, Shell never made any dividend commitments, but few people expected to see any cuts — and we didn’t get any. Shell’s dividend was last covered in 2014 before reported earnings plunged, it should be close to cover for 2017, and 2018 is predicted to see actual above-water cover of about 1.1 times.

That’s not super-safe, but it does make a dividend cut seem very unlikely now too. Forecasts suggest yields of 5.8%, upon which I think we can also rely.

Latest updates

A Q3 update from BP told us that oil and gas production was up 14% in the period, but what crucially caught my eye is that in the nine months, underlying operating cash flow exceeded the company’s organic capital expenditure plus the full dividend.

That sounds like good news for dividend prospects. In fact, BP has also decided to start buying back some shares to cover the dilution caused by scrip dividends — investors opting for scrip have taken some of the pressure off cash dividends over the past few years, and it’s good that there’s enough cash now to start compensating for that.

For its part, Shell reported a 148% rise in operating cash flow for its first nine months of the year — with excellent results from its upstream, downstream and integrated gas businesses. And the recovering oil price is helping boost the value of Shell’s assets. Chief executive Ben van Beurden spoke of “Shell’s growing momentum“, and it really does look like things are on the up.

There’s news on the scrip dividend front too, as Shell announced its scrapping last month along with its own share buyback programme. That’s further evidence that the cash situation is looking a good bit better for the big two.

Time to buy?

I think there’s rarely been a bad time to buy BP or Shell, but right now I’d say we’re on the cusp of a few very solid years. The share prices of both have risen nicely — BP is up 36% since a trough in early 2016, while Shell is up a more impressive 80%.

But we’re looking at modest forecast P/E multiples for 2018 of 17 for BP and 16 for Shell. With the recovery well under way and big dividends that are looking increasingly safe, 2018 really could be a very good year.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell. 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.