Better buy: BP plc vs. Royal Dutch Shell plc

It's taken a while but it appears that oil majors are finally on a firm footing dividend-wise as several years of frantic cost-cutting and crude prices that have stabilised around $70/bbl have led to earnings once again covering once-imperilled dividend payouts. But for investors looking to get on the oil major gravy train, is BP (LSE: BP) or Royal Dutch Shell (LSE: RDSB) the way to go?

It's all about income

On the dividend front there isn't a clear winner because BP's 6.3% yield may comfortably outstrip the 5.45% from Shell, but the latter's healthier balance sheet gives it further scope to substantially increase shareholder returns over the medium term.

In 2017 BP's $24.3bn in underlying cash flow covered organic capital expenditures of $16.5bn, cash dividend payments of $6.2bn, $0.3bn in share buybacks and pushed its gearing ratio down slightly to 27.4%. But adding in other regular uses of cash, fines related to the Gulf of Mexico oil spill and the $1.7bn in scrip dividends paid and BP's financial situation looks slightly poorer than Shell's.

Last year Shell saw free cash flow turn positive to the tune of $27.6bn, which comfortably covered dividend payments of $15.6bn and led management to guide for at least $25bn in share buybacks through 2020. Rising cash flow also lowered the group's gearing ratio substantially to 24.8%, which is particularly impressive given the recent acquisition of BG Group.

Growth at last?

As far as growth prospects go, I'd sooner back Shell over the medium and long term. This is due largely to the group's large natural gas reserves. The BG acquisition made the combined group into the world's largest provider of this cleaner burning, relatively easily transported fossil fuel.

Looking ahead, demand growth for liquefied natural gas (LNG) should continue to outstrip that of traditional crude oil as governments and corporations alike look to lower their carbon footprints while still enjoying the versatility of burning easily-stored, always-usable fossil fuels. Indeed, estimates from Bloomberg New Energy Finance expect global LNG demand to rise from 285MMtpa in 2017 to 490MMtpa in 2030, providing growth prospects and diversification for the likes of Shell.

Neither is a screaming bargain

On valuation grounds, I also prefer Shell, trading as it is at 20.4 times trailing earnings against BP's reported P/E ratio of 38.5. While BP's valuation looks much better on an underlying basis that strips out items such as claims related to the Gulf of Mexico spill, I still see Shell as a more reasonably valued business given its healthier financial situation and growth prospects.

All told, I'd definitely choose Shell out of the two given that it outperforms BP on nearly every metric except for current dividend yield. That said, investors looking to invest for the long-term who prefer to buy and hold their shares throughout the business cycle, would do well to exercise caution towards oil majors right now with valuations far from bargain levels.

Buy-And-Hold Investing

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell B. 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.