For a long time the UK listed oil and gas super-majors were considered laggards compared to their North American peers. In the decade between January 2004 and January 2014, for example, Royal Dutch Shell returned 8.7% per annum assuming dividends were reinvested. BP returned a rather measly 4% per annum on the same basis. In contrast Exxon Mobil generated annual returns of 11.7%, while Chevron’s shareholder returns clocked in at a whopping 14.9% per annum over the same time frame.
The difference is even starker if you look at things from a monetary perspective. Imagine $20,000 split evenly among the Anglo giants (well Anglo and Anglo-Dutch anyway) and the same amount split evenly among the American duo. The former would have returned just under $40,000 compared to the roughly $70,000 generated by the latter.
That said, something interesting has happened to the shares of the British giants recently. If you check out their five-year shareholder returns then you will notice they come out on top, and not by a small margin either. Over the past five years, a period which has seen both very high and very low energy prices, an investment in Chevron stock has returned 4.75% per annum to its shareholders assuming dividends were reinvested along the way. Exxon Mobil shares have fared even worse; they have delivered compound average annual returns of just 1.1%. BP stock on the other hand has generated a respectable return of 8.45% per annum assuming reinvested dividends. Shell is not far behind; its stock has returned 8.15% per annum on the same basis.
It seems to me that a couple of things tend to happen during downturns that are easy to overlook. Firstly, capital expenditures drop a lot more than cash flow as companies scramble to conserve cash. All of the above mentioned oil majors have followed this trend over a five year stretch. Secondly, those companies become much more lean when they go through nasty spells like a prolonged commodity price drop.
The upshot is that free cash generation recovers better than you might initially expect. Compare 2015 and 2017 for instance. In those two years the average annual oil price was actually very similar (roughly $50-$55 per barrel of Brent crude). However, between them the four oil majors made $40 billion more in free cash in 2017 compared to 2015. As it happens that was roughly the size of their annual cash dividend bill for last year.
In that sense Shell and BP’s respectable performances aren’t really all that surprising. Both companies generated free cash flow levels that, a few years earlier, would have seemed unlikely at that kind of oil price. That said it doesn’t explain why our other two have lagged so badly in comparison, especially given that their finances have also improved markedly.
Playing The Oil Game
P/E ratios are often useless for commodity companies. I know I have made that point before on the site but it is an interesting one that can potentially save (or make) people a lot of money over the long-run. The reason for this is that there is a tendency for P/E ratios to be very low during commodity bull markets because the ‘E’ is very high. Conversely, when the ‘E’ is very low the P/E ratio often looks unattractive during price slumps. The upshot is that some of the best times to invest in oil & gas stocks can be when their P/E ratios are fairly high. Perversely this also tends to be the time when their operations and finances are taking a bettering from low prices.
As a rule of thumb look out for when the conventional valuation metrics, such as dividend yields, look okay even in an uninspiring price environment. Take Shell and BP across 2016 and 2017 for instance. During those two years the average price of a barrel of Brent crude was just under $50 per barrel. That is a shade under the inflation adjusted price going back to around 1980. In other words the couple of years have actually been fairly unremarkable in terms of the pricing environment. As it happens BP and Shell posted pretty stodgy yields for those years; both averaged nearly 7%. But look at their US counterparts – Exxon Mobil’s average dividend yield was 3.6%, while Chevron’s was around 4%. The value proposition looks to have been a fair bit more attractive for the former two compared to the latter.
In any case the market seems to have cottoned on to this. That group of four currently trades in the 15-17x earnings range; not particularly cheap in the current $80 per barrel price environment. Nonetheless the last few years have proved an interesting lesson for those who were once writing off Shell and BP as inferior investments.