4 Smaller Alternatives to BP and Shellhttp://www.fool.com/investing/international/2012/08/22/4-smaller-alternatives-to-bp-and-shell.aspx Roland Head
August 22, 2012
LONDON -- If you want blue chip, dividend-paying exposure to the oil and gas industry, then most investors look no further than BP or Royal Dutch Shell. After all, smaller oil and gas companies are high risk and volatile -- aren't they?
Of course, small oil and gas exploration and production companies can be extremely risky, but there is another class of oil company that does offer a serious alternative. Let me explain.
Staying the course
Just occasionally, however, small companies remain independent and manage to develop their own resources -- transforming themselves into larger independent oil companies, with stable revenues, large profits, and long-term viability.
I recently decided to take a look at some of the top independent companies in the FTSE 100 (UKX) and the FTSE 250, to see if any looked like attractive longer-term alternatives to Shell and BP.
Source: Digital Look, Morningstar, company reports.
It's immediately obvious that there are some massive differences between the companies, which are reflected in their price-to-earnings ratios, dividend yields, and commercial reserves.
Over the last 10 years, BG Group has delivered an average yearly total return of 17.9%, compared to 6.8% for the FTSE 100 and 6% for Shell. Although its growth is likely to slow, I think that long-term investors who buy in now will still enjoy healthy returns. As an added incentive, BG Group is down 5% so far this year, offering new investors a relatively attractive entry price.
These are exceptional success rates and are the main reason Tullow shares are priced so highly, with a P/E of almost 30. Although Tullow's commercial reserves are relatively modest, its contingent resources -- which are discovered but not yet proven to be commercial -- are substantial at 1,445 million boe, and investors are willing to pay for these and for Tullow's expected future exploration successes.
Today, it's a different type of company and Dragon's low P/E and relatively high yield tell the story. Although it is involved in some exploration -- it was recently awarded a license in Iraq and has assets in Tunisia -- its main business is developing and expanding its Turkmen production assets.
Dragon's sizable reserves are enough to sustain production at current rates for nearly 30 years, making it something of a cash cow.
Premier has assets in the North Sea, Africa, and Asia and its production output is growing steadily. It is also expected to pay its maiden dividend this year, albeit a small one.
Independents vs. supermajors
Based on these criteria, which of these four independents looks the most attractive?
Perhaps unsurprisingly, I think that the largest -- BG Group -- offers the best potential as a "hold forever" share, while the smallest -- Premier Oil -- is the most likely to deliver strong growth or be taken over. It's also the riskiest, with a lot to prove in the Falkland Islands.
I can't see another oil company wanting to buy Tullow Oil unless it becomes much cheaper, and while Dragon Oil offers good value for money, it is probably the strongest financially. Dragon's net cash balance of $1.5 billion means it has little reason to sell, unless its major shareholders want an exit. However, if oil prices stay high, expect Dragon Oil to deliver considerable further growth, as it's very