Better buy: Royal Dutch Shell plc vs Premier Oil plc
The outcome of this week's OPEC meeting is likely to be positive for the oil sector. It means that supply will be cut, which could lead to a higher oil price over the medium term.
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Clearly, it's a volatile period for the industry and the future remains uncertain. As with all sectors, though, the best time to buy can be when the future is least clear. Therefore, buying the likes of Premier Oil(LSE: PMO) and Shell(LSE: RDSB) could be a worthwhile move for patient investors.
Both companies have endured a highly challenging period as a result of the oil price collapse. However, they've adapted their business models and sought to take advantage of low asset prices in order to improve their respective asset bases.
In the case of Premier Oil, it has reduced costs and become increasingly efficient. This has helped it to become more competitive versus its peers. It has also been involved in M&A activity through the purchase of Eon's North Sea assets. This should improve Premier Oil's growth outlook and also boost its overall diversity, resulting in a lower risk profile.
Ambitious acquisition
Meanwhile, Shell has been more ambitious in its acquisition programme. It has purchased BG Group and has become a major player in liquefied natural gas (LNG) production. This should help Shell to stay relevant as the world gradually shifts towards the use of cleaner sources of energy. The company has also become leaner through cost reduction, while moving away from higher risk exploration activities. This should help to improve cash flow and lead to a more financially sound business over the long run.
In this respect, Shell has greater appeal than Premier Oil. It has a stronger, more diversified and lower risk asset base as well as a better balance sheet and cash flow. This has enabled Shell to maintain dividends throughout the oil price crisis, with the stock yielding 7.1% versus 0% for Premier Oil. In fact, Premier Oil has been lossmaking in each of the last two years. This shows that it may not be able to cope with oil price falls as well as Shell, should they occur in future.
Despite this, Premier Oil is expected to return to profit in the current year. It trades on a forward price-to-earnings (P/E) ratio of 35, which lacks appeal when considered next to Shell's forward P/E ratio of 13.8. And with Shell's free cash flow forecast to rise over the next few years as the integration of BG takes place, the outlook for its financial performance and dividend payments is bright.
Although Premier Oil may be worth buying for the long run, Shell offers lower risk and higher potential rewards. It has a lower valuation, better income potential and a higher quality, better diversified asset base. Therefore, it's the better buy of the two oil and gas stocks.
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Peter Stephens owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended 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.
