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By Ahmed Ishtiaq

Depreciation of purchasing power is one of the biggest concerns for income investors. Investing in commodities can be the best way to tackle the demon of inflation. However, commodities can present problems such as, no income, storage costs and lower liquidity. Although commodities provide an exceptional hedge against inflation, the market may not give the desired price if you have to sell in a hurry. Oil and gas sector provide an excellent hedge against the inflation and an opportunity to make substantial gains. The sector has been one of the best dividend payers historically and still holds some of the juiciest dividend yields in the market.

We decided to choose three stocks from the sector, which have attractive dividend yields, strong financial position and solid growth prospects.

British Petroleum (BP)

British Petroleum is one of the biggest names in the oil and gas sector. Over the past three years, BP revenues have increased considerably. However, the costs for the company have also been increasing. Over the past two years, the company has suffered deeply due to the Macondo well disaster. However, BP has raised $35 billion, including $11 billion in the third quarter, by selling assets to meet the obligations of the oil spill. Further, the company has announced an agreement to sell its 50% share in TNK-BP to Rosneft, a Russian integrated oil and gas company. BP will receive $17.1 billion in cash and shares representing 12.84% of Rosneft. After the completion of the transaction, BP will hold 19.75% of Rosneft.

During the third quarter earnings announcement, the company announced a key change in the focus of its operations. Management outlined its plan beyond 2014, turning the focus to exploration and oil from gas and refining business. A shift to exploration and liquids will provide stability in revenues and increased growth opportunities. In addition, the company increased its quarterly dividends to $0.09 per share ($0.54 per ADS). Based on the current price, dividend yield for BP is 5.2%. Moreover, the stock is trading at a P/E ratio of 7.5, compared to an industry average of 9.6. Recent increase in dividends is an indication that the company is optimistic about the future growth prospects.

ConocoPhillips (COP)

ConocoPhillips (COP) is the world's biggest production and exploration company based on oil production and reserves. The firm searches for gas and oil in more than 30 countries and has reserves of 8.4 billion barrels of oil equivalent. ConocoPhillips has demonstrated massive revenue growth during the past three years. At the end of 2009, ConocoPhillips revenues stood at $152.4 billion, which climbed up to $251.2 billion by the end of 2011. Consequently, net income for the company almost tripled over the past three years. For the most recent quarter, earnings of the company fell by 31% due to the spin-off of its refining business. The company is trying to reposition itself by shedding some of its assets and making its balance sheet stronger.

ConocoPhillips plans to sell between $15 billion to $20 billion worth of assets and repurchase a substantial amount of its shares outstanding. Recently, the company announced the intention to sell its assets in the North Caspian Sea for about $5 billion to ONGC Videsh Limited of India. ConocoPhillips is trying to shift from natural gas to oil due to the low prices and has increased its presence in oil rich shale plays like Bakken and Eagle Ford. At the moment, the stock pays an annual dividend of $2.64, yielding 4.65%. A change in the business model and a shift towards oil will improve the earnings of the company and help it reward its shareholders in the long term. Furthermore, the stock is trading at a P/E ratio of 7.0, less than the industry average of 9.6.

Royal Dutch Shell (RDS.A)

Royal Dutch Shell is an integrated energy company with exploration, production, and refining operations worldwide. Shell has production of more than 3 million of barrels of oil equivalent (BOE) a day, making it one of the largest energy companies in the world. The company has shown remarkable growth in revenues over the years. At the end of 2009, revenues stood at just above $285 billion, which grew to over $484 billion by the end of 2011. For the trailing twelve months, the company has recorded revenue of over $478 billion, and basic EPS of $8.46.

Furthermore, Shell generates massive amounts of cash flows from its operations. Over the past twelve months, the company has generated over $42.6 billion in operating cash flows. However, a substantial amount of its cash flows is spent on capital expenditures. Shell has spent over $31 billion on capital expenditures during the past twelve months. As a result, trailing twelve months free cash flows for the company are $10.8 billion. However, Shell free cash flows are adequate to cover its dividend payments. The company paid 7.774 billion in cash dividends during the previous twelve months, which takes its payout ratio to 71.5%.

At the moment, the company pays a quarterly dividend of $0.86 per ADS, yielding 5.15%. Shell derives almost 90% of its revenues from refining activities. At the moment, the margins are slim in the refining business. However, a low exposure to the oil prices should provide stability to its revenues. Furthermore, the stock is trading at a P/E ratio of 7.9, compared to the industry average of 9.6.

Summary:

The companies mentioned in this article are some of the biggest names in the industry. These companies have strong business models and solid market positions. Almost all of these companies have a tremendous track record of impressive performance and healthy cash flows generation. Although global economic recovery is slow, the demand for oil and gas in on the rise. I expect these companies to show strong performance over the next year and reward their investors handsomely. Moreover, all of these stocks are trading at attractive multiples.

Disclaimer: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: 3 Oil Giants For Attractive Dividend Yield