Finding Value in Big Oil

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The oil industry is a risky business, as BP (NYSE: BP) shareholders found out a few years ago. But high risk comes with high reward, and a sensible investment in oil can produce big returns for investors.

<img src="/media/images/user_14485/oil-vs-sp-500_large.png" />

Big oil vs. the S&P 500 - Source: Google Finance

This chart shows the three major integrated oil and gas companies in the S&P 500: ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX)Conoco Phillips (NYSE: COP), as well as world behemoth Royal Dutch Shell (NYSE: RDS-B). All but Shell have significantly outperformed the S&P 500 over a 10 year period.

But where to invest?

With the four major firms all providing such good and varied returns, where do you invest your money right now for the future?

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p><strong>PEG</strong></p> </td> <td> <p><strong>Dividend yield per share</strong></p> </td> <td> <p><strong>Dividend cover</strong></p> </td> <td> <p><strong>3yr Dividend growth</strong></p> </td> </tr> <tr> <td> <p>XOM</p> </td> <td> <p>10.91</p> </td> <td> <p>1.47</p> </td> <td> <p>2.26%</p> </td> <td> <p>4.2</p> </td> <td> <p>5.29%</p> </td> </tr> <tr> <td> <p>CVX</p> </td> <td> <p>8.56</p> </td> <td> <p>6.07</p> </td> <td> <p>3.40%</p> </td> <td> <p>4.3</p> </td> <td> <p>7.81%</p> </td> </tr> <tr> <td> <p>COP</p> </td> <td> <p>9.47</p> </td> <td> <p>n/a</p> </td> <td> <p>4.74%</p> </td> <td> <p>3.4</p> </td> <td> <p>11.91%</p> </td> </tr> <tr> <td> <p>RDS-B</p> </td> <td> <p>8.5</p> </td> <td> <p>1.9</p> </td> <td> <p>4.94%</p> </td> <td> <p>3</p> </td> <td> <p>0%</p> </td> </tr> </tbody> </table>

Data Source: Motley Fool CAPS

Currently, on a foreword P/E basis, Chevron and Shell look the cheapest. Exxon is the winner when it comes down to the PEG ratio; Conoco Philips has a negative PEG ratio, as earnings are expected to be down this year. Shell is currently the winner on yield. Exxon and Chevron have the best cover, but Shell's high yield has the lowest coverage in the group. The winner for the best payout growth goes to Conoco, which has produced a compounded dividend growth rate of 11.91% over 3 years, which is an average of 3.97% a year.

What about historic growth?

<img src="/media/images/user_14485/5-yr-eps-oil_large.jpg" />

Data Source: Motley Fool CAPS, FT online

Both Conoco and Shell have had negative earnings growth over the past 5 years. Meanwhile, Chevron has had the best growth over this period, and Exxon comes in second place. It would be easy to think that these earnings would be highly correlated, with all of these firms being involved within the same sector with the same commodity, as earnings rise and fall with oil prices. However, when we take a closer look at the quality of the earnings we can see how Chevron is able to grow faster than others.

Earnings Quality

<img src="/media/images/user_14485/profit-margins-oil_large.jpg" />

Data Source: Motley Fool CAPS

Despite having the higher gross margins, ExxonMobil is inefficient. Chevron has the second biggest gross margins after Exxon, but has the strongest pre-tax margin of the whole group.


<img src="/media/images/user_14485/np-per-dollar-oil_large.jpg" />

Data Source: Motley Fool CAPS

Put simply, Chevron generates 2.6 cents per dollar of revenue more than Exxon. Royal Dutch Shell only generates 10.5 cents for every dollar in revenue; that is 55% less than Chevron!

So far we can see that Chevron presents the best growth opportunity, has the lowest forward P/E multiple, and comes with a well covered 3% yield. Exxon follows closely with a slower growth story, smaller yield, but a better looking PEG ratio.

Before we decide which we would like to buy, it would be good to know what products these companies are involved in. Although they all specialize in oil, they do not specialize in the same areas of the commodity, as they would all have the roughly the same earnings growth as earnings fluctuated with oil prices.

So what do these company’s do?

Revenue Composition

<table> <tbody> <tr> <td> <p><span>Company</span></p> </td> <td> <p><span>Refining and distribution</span></p> </td> <td> <p><span>Hydrocarbon exploration and production</span></p> </td> <td> <p><span>Other</span></p> </td> </tr> <tr> <td> <p><span>XOM</span></p> </td> <td> <p><span>81.1%</span></p> </td> <td> <p><span>9.9% - Worldwide leader 2.3 million barrels of oil per day</span></p> </td> <td> <p><span>9% - petrochemicals, oils, aromas, alcohols, ethylene, elastomer's, propylene, and polymers</span></p> </td> </tr> <tr> <td> <p><span>CVX</span></p> </td> <td> <p><span>71.7% - 20,000 km of pipeline, 50 ship fleet, involved in plastics production</span></p> </td> <td> <p><span>27.7% - 1.8 million barrels & 139.7 million cubic feet of natural gas</span></p> </td> <td> <p><span>0.6% - electricity production</span></p> </td> </tr> <tr> <td> <p><span>COP</span></p> </td> <td> <p><span>76.2%</span></p> </td> <td> <p><span>20.2% - 1.6 million barrels & 127.8 million cubic feet of natural gas</span></p> </td> <td> <p><span>0.1% - electricity and petrochemicals</span></p> </td> </tr> <tr> <td> <p><span>RDS-B</span></p> </td> <td> <p><span>91% - involved in the manufacture of petrochemical products</span></p> </td> <td> <p><span>9%</span></p> </td> <td> <p><span>n/a % - renewable energy</span></p> </td> </tr> </tbody> </table>

 Data Source:

This table gives us a much better understanding of what these firms do. We can see how Chevron has managed to outgrow its competitors. Chevron has a much higher revenue weighting to hydrocarbon production in its revenue; this business has a significantly higher margin than that of refining. 

<img src="/media/images/user_14485/average-margins-oil_large.jpg" />

Data Source: European Refining Margin Indicator (ERMI),

Even though Exxon is the world's largest oil producer, only 9.9% of its revenues actually come from the high margin oil business. 81.1% of Exxons revenues come from the low margin refining. Shell has the same type of revenue structure.

Based on this, the company that stands out is Chevron, with its large distribution network and heavy weighting to oil production. Chevron looks to be the best diversified oil major in the S&P 500.

rupert12345 has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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