With a respective market cap of $127.4 billion and $77.7 billion, Royal Dutch Shell plc RDS.A and BP plc BP dominate the energy sector. Although the European biggies have high debt load and are thus vulnerable to the energy market downturn, there are reasons for investors to favor Royal Dutch Shell over BP.
Energy Market Downturn
The coronavirus pandemic has hammered global energy demand. Strict social-distancing measures to combat the spread of the virus have drastically reduced demand for fuel, which in turn has resulted in an oil price plunge since the beginning of 2020. From more than $60-a-barrel in the beginning of 2020, the price of West Texas Intermediate (WTI) crude has slipped more than 33%.
In the second quarter, exploration and production activities contracted significantly since several energy majors curtailed capital spending to survive the effect of the coronavirus-induced low commodity prices.
Also, investors are concerned about a new wave of coronavirus infections and uncertainties about the extent to which the economy and energy market can recover in the second half of 2020. Hence, with the widespread uncertainty, significant recovery in oil and gas activities over the last six months of the year doesn’t seem like a possibility.
Bad for European Biggies
The weakness in oil prices is definitely bad news for the European energy majors since the balance sheets of both BP and Royal Dutch Shell are significantly more levered than the composite stocks belonging to the industry.
Hence, it is likely that neither BP nor Royal Dutch Shell can rely on their balance sheet strength to keep investing in business and return cash to shareholders, especially in the present challenging business scenario. In comparison, U.S. energy giants Exxon Mobil Corporation XOM and Chevron Corporation CVX have strong balance sheets and are better-positioned.
Shell’s Edge Over BP
The market is well aware that in April, Royal Dutch Shell cut its dividend by 66%, mostly to survive the pandemic. Importantly, the move has made it possible for the integrated energy major to lower annual dividend payments by a massive $10 billion, thereby creating additional financial flexibility.
The sizable chunk of money will make Royal Dutch Shell more resilient to weak oil. The company will also be able to sustain and grow its value, thereby securing more cashflows for shareholders.
Many analysts opine that Shell will deleverage quickly with the massive cash savings from the dividend cut and will reach its gearing target of 25%. Notably, gearing signifies net debt as a percentage of total capital.
BP, however, has significant debt load and its balance sheet is considerably more levered than most peers, thereby limiting its financial flexibility. Notably, BP’s gearing of 36.2%, as of the March quarter of 2020, compares with Royal Dutch Shell’s 28.9%. Hence, we can say that BP is more vulnerable to energy market downturns. Investors should know that BP’s balance sheet has piled up huge debt balance owing to the Gulf of Mexico oil spill incident on Apr 20, 2010, and the 2018 acquisition of U.S. unconventional onshore resources.
In case of the Zacks Rank as well, Royal Dutch Shell has a clear lead with a Zacks Rank #2 (Buy), while BP carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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Exxon Mobil Corporation (XOM) : Free Stock Analysis Report
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Royal Dutch Shell PLC (RDS.A) : Free Stock Analysis Report
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