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Why I’m cautious on the Hurricane Energy share price, and would rather buy Shell instead

The operational update released by Hurricane Energy (LSE: HUR) on Thursday highlighted the progress being made with its Lancaster Early Production System (EPS). The oil and gas exploration and development company is on track to produce first oil from the project by the middle of 2019, with its finances set to gain a boost from doing so.

However, the company’s share price has risen sharply in recent months. Its valuation does not now appear to be as appealing as it once was. As a result, FTSE 100 oil and gas producer Shell (LSE: RDSB) could offer a stronger risk/reward ratio for the long term.

High returns

In the last year, the Hurricane Energy share price has risen by 100%. Even though the oil price has made gains in the same time period, it is still a stunning return for the company’s investors. Sentiment seems to have improved as a result of encouraging news flow released by the business, with the prospect of first oil in 2019 and the subsequent increase in profitability causing the stock to command a higher valuation.

Now, though, the company may lack the wide margin of safety which once made it a highly enticing play on the oil price. Using 2019 forecast earnings, the stock has a price-to-earnings (P/E) ratio of around 23.5. This suggests that investors are pricing-in the success of its Lancaster EPS, and the financial results which could follow. And while there may still be upside potential in the long run, other oil and gas companies, such as Shell, may now offer superior investment prospects.

Risk/reward

Shell’s P/E ratio of 13 is clearly much lower than its smaller industry peer. This helps to reduce the risk of investing in a company that remains highly dependent upon the oil price for its financial returns. With it having a diverse asset base which is relatively large and efficient, the company appears to provide a resilient growth outlook for the long term. Falling debt levels and rising free cash flow could provide financial strength in the coming years should the oil price disappoint.

The FTSE 100 stock, though, is not just a relatively low-risk opportunity. It also offers high growth potential, with its bottom line due to rise by 18% in the next financial year. This puts the stock on a price-to-earnings growth (PEG) ratio of just 0.7, which suggests that it offers growth at a reasonable price. Added to this is a dividend yield of 5.7% which is well-covered by profit at 1.5 times. This indicates that the stock’s total return could be high over the medium term.

As such, Shell seems to offer a more appealing risk/reward ratio than Hurricane Energy. It appears to be one of the few stocks in the FTSE 100 that offers good value for money, a high yield and double-digit earnings growth potential over the medium term. As such, now could be the perfect time to buy it.

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Peter Stephens owns shares of Royal Dutch Shell B. The Motley Fool UK has no position in any of the shares mentioned. 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.