Why I'd buy BP plc over Cairn Energy plc after today's news

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BP petrol station

Cairn Energy(LSE: CNE) has released an upbeat trading update that shows that the company is on the right track. Notably, it believes the next year will be an eventful one for the business, with exploration and appraisal drilling set to take place. And with it having sound finances in terms of being fully funded for its future prospects, it could prove to be a strong performer. However, BP(LSE: BP) could be an even more enticing buy. Here's why.

Significant potential

Cairn's balance sheet has a net cash position of $335m. This provides it with sufficient capital through which to embark on an ambitious programme during 2017. Already, it has drilled six successful wells in Senegal and plans to embark on further exploration and appraisal drilling in the coming year. Furthermore, it plans to continue development of its North Sea assets, where it's working towards first oil and cash flow.

Both the Catcher and Kraken developments in the North Sea are on target for first oil in 2017, with a peak net targeted production to Cairn of around 25,000 boepd (barrels of oil equivalent per day). Alongside this, a third phase of drilling is to start thismonth in Senegal, with a further evaluation of the SNE discovery. While the company is currently unable to access its 10% residual shareholding in Cairn India, it's confident in the strength of its case to seek damages.

An improving outlook

Clearly, the rising price of oil in recent months is a positive for Cairn and the wider oil and gas industry. The reduction in supply by OPEC means the price of oil could realistically move higher in the coming months. Therefore, the wider sector could prove to be a sound place to invest, with a number of large, profitable companies trading at low valuations.

For example, BP is forecast to increase its bottom line by 125% this year, followed by further growth of 23% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.6, which indicates that it offers excellent value for money. Similarly, its dividend yield of 6.2% is also becoming more appealing. It's due to be covered 1.25 times in 2018, which indicates it's sustainable over the long run and could even rise in future years.

By comparison, Cairn is expected to remain lossmaking in the current year. While its net cash position is strong and it's due to move into profitability next year, this already seems to have been priced-in by the market. The company has a forward price-to-earnings (P/E) ratio of 18.7 versus just 12.8 for BP. Therefore, due to the latter's higher profitability, better valuation and income appeal, it seems to be the better option at the present time.

Certainly, Cairn could prove to be a star buy in the coming years, but with lower risk and higher potential rewards, BP could outperform it over the medium term.

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Peter Stephens owns shares of BP. The Motley Fool UK has recommended BP. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.