Because crude prices have declined so much, supermajors have been under pressure as never before. In February, ConocoPhillips (NYSE: COP) cut its dividend to $0.25 from $0.74, with CEO Ryan Lance saying, 'While we don't know how far commodity prices will fall, or the duration of the downturn, we believe it's prudent to plan for lower prices for a longer period of time."
In the same month, ExxonMobil (NYSE: XOM) reported that its fourth-quarter quarter profit dropped a stunning 58%. European supermajors haven't been immune to the fallout, either. Both BP (NYSE: BP) and Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B) have seen their stocks fall substantially over the past year, with BP previously trading at levels not seen since the Gulf of Mexico accident and Shell trading for prices not seen since 2009. Because of the declines, these two supermajors pay attractive dividend yields, with BP yielding 7.66% and Shell yielding 6.87%. Given that both companies have long and storied histories and pay generous dividends, which company is a better buy?
Shell has a bigger downstream unit
Royal Dutch Shell is, in some ways, a better company than BP. Shell's downstream unit is more profitable, for example. Shell's downstream unit made $1.52 billion last quarter, and $9.75 billion last year, versus BP's downstream pre-tax replacement cost profit of $1.2 billion last quarter and $7.5 billion last year.Shell is also the undisputed leader in LNG, which is expected to be a big growth area in the coming years, while BP has lagged behind Shell in that front.
BG acquisition synergies may be difficult to realize
Although Shell is, in some ways, better than BP, there is one area that might make Shell worse than BP going forward. Because Shell completed its $53 billion acquisition of BG Group (with a substantial portion being paid in cash) in February, Shell's debt to cash flow is worse than before. The acquisition will also force Shell to sell more non-core assets than it otherwise would have done.
Shell made the BG acquisition because it believes BG is highly complementary to the company's strategic priorities of LNG and deepwater. Because BG is a major LNG player, Shell's acquisition of BG would solidify Shell's position as the LNG leader. Because BG has major assets in deepwater Brazil, the BG acquisition would help Shell expand in an area where it was weak. Moreover, because BG's production is growing, Shell's acquisition of BG would help Shell offset its production declines without the company having to spend on expensive organic development.
Although acquiring BG makes strategic sense, the deal might not deliver in terms of the actual expected results of being strongly accretive to EPS from 2018 and onward, however. Integrating a company BG's size is always difficult, and many things can go wrong between now and 2018. With BG's LNG and deepwater operations, Shell is basically tying itself to longer tail development and higher breakeven cost at a time when other competitors are focusing on shorter cycle, lower capital commitments such as shale development. If commodity prices don't rebound, the BG acquisition won't deliver as much value as management had hoped.
While they may have no choice but to cut their dividends if energy prices stay lower for too long, both BP and Royal Dutch Shell are both good long-term buys, because they will survive the energy downturn in one shape or another. Both companies have solid balance sheets, strong operating cash flows, and wide moats that give each company flexibility to pursue their individual goals. With the BG acquisition, Shell is at the moment prioritizing long-term growth, while BP is prioritizing maintaining its dividend. Given that delivering on promised synergies with a company of BG's size is difficult, BP is a safer buy, but Royal Dutch Shell has more upside.