While the recent challenges posed by China are causing understandable worry among investors, the outlook for the oil industry has been downbeat for a number of months. In fact, while the FTSE 100 was making record highs earlier this year, oil was plunging from well over $100 per barrel in 2014 to below $50 per barrel. And, looking ahead, it would be of little surprise if further declines in its price level take place in the short run, as investors continue to lose confidence in the sector.
Clearly, such a decline has had a major impact on the share prices of oil producers such as BP (LSE: BP) and Premier Oil (LSE: PMO). Their valuations have fallen by 27% and 71% respectively in the last year alone and many investors, therefore, may be of the view that neither stock is worth buying due to weak investor sentiment.
However, both companies have strong long term prospects and, when combined, appear to provide the perfect oil partnership. That’s because the two companies are very different and, while they are focused on the production of oil, complement each other well.
For example, BP has a relatively low level of debt on its balance sheet, with its debt to equity ratio currently standing at just 47%. This indicates that it is a relatively low risk entity and, with there being concerns surrounding the financial standing of oil stocks, BP should provide its investors with a degree of confidence in this regard – especially since its interest coverage ratio stands at a healthy 5.6.
Meanwhile, Premier Oil appears to be a riskier proposition with regard to its financial standing. Its debt to equity ratio is far higher than that of BP, with it being 115%. And, in financial year 2014, its finance costs were $196m and, since Premier Oil was loss-making at the operating profit level, they were not covered by profit.
This is a cause for concern for the company’s investors – especially since Premier Oil is expected to remain loss-making in the current year. However, with a pretax profit of $144m being forecast for next year, Premier Oil’s financial standing should gain a real boost and this is likely to have a positive impact on market sentiment.
In terms of their geographical exposure, BP remains far more diversified than Premier Oil. That is perhaps to be expected, since it is a much bigger company and, in this regard, offers a less risky profile than Premier Oil. In other words, challenges in one region are unlikely to hurt BP to the same extent as they would Premier Oil, which makes the former a more resilient investment. In addition, BP’s yield of 7.6% indicates that it is a far better income play, with Premier Oil currently not paying a dividend.
While the two companies are very different in terms of their financial standing, geographical diversity and income prospects, they both offer excellent value for money. For example, BP trades on a price to book (P/E) ratio of 0.91, while Premier Oil’s P/B ratio of 0.44 is even lower. As such, both companies could post stunning share price gains in future, with Premier Oil’s riskier balance sheet, more concentrated regional exposure and lack of dividend being made up for by a super-low valuation. And, alongside BP’s relative stability, diversity and financial strength, the two make for a top notch oil sector combination for the long term.
