Oil stocks have faced a torrid time over the last couple of months. This has even seen oil prices briefly turn negative, due to the significant lack of demand. But with supply being restricted, and demand also picking up, the price of Brent Crude has now reached over $42. This should rise further once restrictions are lifted and activity returns to normal. Therefore, it could be the perfect time to capitalise on cheap oil stocks. My top pick is Royal Dutch Shell (LSE: RDSB) shares.
The cut dividend
It was a major surprise when Shell cut its dividend by 66% for the first time since the Second World War. But while disappointing in the short-term, I believe that the dividend cut will benefit Shell shares in the future. In fact, the cut will save it around $10bn a year and will help shore up the balance sheet. Shell shares are also still yielding nearly 4%, which is significantly more than many stocks on the FTSE 100 at the moment. Furthermore, the new dividend is more sustainable that its previous yield of over 10%.
Adapting to a new environment
Management has seemed very aware of the changing environment for oil shares and looks as if it will be able to adapt. This has included investing in lower-carbon technology. I recently wrote about how I think the future is in renewable energy, and Shell has increased its exposure to renewables in the past few years. This has included a growing network of hydrogen stations, the use of biofuels, and investment into solar energy. I believe this will ensure the longevity of the company and benefit Shell shares in the future.
Shell has also suspended its programme of buying back shares. This will help provide further liquidity to the firm during this time. But this should not take away from the fact that Shell has made a number of poor decisions recently. An example is spending $16bn in two years on buying-back shares at the price of £22. Net debt of over $70bn may also seem fairly unsustainable at this moment.
Shell shares are extremely cheap
Despite these mistakes, the current price is still ridiculously cheap. In fact, Shell shares have lost around 40% year-to-date. This has left them trading at a price-to-book ratio of 0.8 and a P/E ratio of 7.9. Both these figures indicate an extremely cheap valuation. The quality and leading market position of the firm also places the stock in a better position than others in the oil industry. This includes names such as Tullow Oil and Premier Oil which, while extremely cheap, seem at a much greater risk of collapse. The price of Shell shares has also been pushed considerably lower than BP, which has maintained a potentially unsustainable dividend. This means that I think Royal Dutch Shell offers the best opportunity for those who want to invest in the oil recovery.
