The past two years haven't been kind to the oil industry as plummeting crude prices have devastated profits and shone a light on the sky-high debt many producers carry. But investors shouldn't forget that the oil industry is a cyclical one and the best time to buy shares is when they're out of favour. So, are hardy contrarian investors looking for exposure to the industry better off buying BP (LSE: BP) or Shell (LSE: RDSB)? To answer this question, we'll grade both companies on profitability, dividends, debt and long term potential.
Profitability through first nine months of 2016
Net cash from operations
If we just look at the pre-tax profits, Shell is the runaway winner compared to BP. But this is skewed by Gulf of Mexico-related charges, including $6.3bn in costs and $2.8bn in tax credits during the period. If we look at the cash each company's operations bring in compared to revenue, they're broadly similar.
And when it comes to surviving low oil prices, both majors are in roughly the same boat. BP is targeting balancing capex, opex and dividends at $50-$55/bbl and Shell's targets won't be far off this mark. So once Gulf of Mexico related payments begin winding down in the next two years, BP and Shell are likely to have similar levels of profitability. That means there's no clear winner when judged by this metric. So on to the next one.
Cumulative dividends paid in 2016
Once again, BP and Shell largely fail to differentiate themselves when judged by the income shareholders are receiving this year. As far as the sustainability of these 7%-plus yields go, neither company is in very good shape. That's obvious if we compare the profits each has made in 2016 with how much they've paid out in dividends. With similar yields and similarly uncovered dividends, we can't give either company a clear victory on this metric either.
In this regard BP is in much better shape than Shell. The reason for Shell's high debt, aside from normal operating debt and paying for uncovered dividends, is the $53bn acquisition of competitor BG group earlier this year. Paid for with a combination of debt-financed cash and stock, this was the main driver for Shell's gearing rising from 12.7% in September 2015 to the current 29.2% year-on-year. With net debt rapidly approaching the high end of the 20%-30% range management is targeting, Shell loses to BP on this topic.
Long term view
However, while Shell's debt is worrying in the short term, the reason it rose so dramatically, that BG acquisition, also makes it a more appealing option than BP in the long term. That's because the addition of BG makes Shell the world's largest commercial supplier of liquefied natural gas (LNG). As developed economies turns away from dirty burning fossil fuels such as oil and coal, LNG is becoming more popular as a cleaner burning alternative. Although LNG prices have also suffered in the last two years, the long-term outlook for this easily transportable yet fairly clean fossil fuel are much brighter than oil. For that reason, I'd be picking Shell if I had to own one oil major for the next few decades.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.