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Shell vs BP: which oil giant should you buy?

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By James Connington14 NOVEMBER 2016 

In the hunt for income‑producing stocks, BP and Royal Dutch Shell are two obvious candidates.

Both have so far kept dividend promises made before the oil price crash, leading to hefty yields: 7pc for BP and 6.7pc at Shell. But which firm is better placed to sustain such attractive dividends?

At first glance, it can look like splitting hairs. Each is prioritising dividend payments, although there is little chance of dividend growth.

Both have taken significant action to cut costs and sell assets in response to the lower oil price.

They are also evenly matched on dividend cover, which is the ratio of a company’s net profit to the amount promised in dividend payments.

In other words, it’s a measure of a company’s ability to pay a dividend from profits alone.

According to the latest figures, for 2016, Shell’s dividend cover is 0.5 and BP’s is 0.4, meaning neither is paying its dividend purely out of profit. Both have a forecast of 1 for next year, according to broker AJ Bell.

But there are key differences: Shell spent £40bn to buy BG Group, a rival firm, earlier this year, while the financial cost of the Deepwater Horizon accident was disastrous for BP.

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Liz Dhillon, an analyst at investment manager Quilter Cheviot, prefers Shell.

She said: “I was positive on Shell’s takeover of BG. It has effectively bought future reserves, which all big companies are struggling to replace. I think it has sufficient flexibility in terms of costs and asset sales to maintain the dividend.”

Ms Dhillon said Shell’s “dividend first” policy might have to change if the oil price performed poorly, but “in a reasonably positive scenario I think the dividend is safe”.

She added: “I don’t dislike BP, and again don’t see much short-term threat to the dividend. My longer-term concerns are its focus on higher-risk areas such as Russia and the lack of growth in new exploration. It will need to spend more.”

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BP also sold out of “an awful lot of potential growth” to meet the cost of the Deepwater Horizon disaster, Ms Dhillon said.

Eric Moore, manager of the Miton Income fund, holds both firms in the top 10 of his portfolio. He prefers BP, but said the yield figures for both companies implied that the market didn’t think either was sustainable.

“Generally, things that yield more than 6pc don’t do so for long,” he said.

“They are both reliant on the idea that oil goes back to $60 by the end of the decade. If you want to hang your hat on those yields, you can’t get away from that.”

His preference for BP stems from the timing of cost cutting and investment by each firm.

“Shell spoke of a $70‑$110 range and kept spending assuming $100 oil. It has belatedly been cutting costs and canning projects, but its behaviour is cyclical, investing at the top and cutting at the bottom,” he said.

Mr Moore said he would like to see Shell investing now, while there are cheap assets and less competition for new oilfields. By comparison, he said BP had been making cuts and selling assets far earlier, putting it in a better position to invest now.

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