The oil industry tends to be one of the most popular industries to invest in. It's very rare to meet an investor who doesn't have at least one oil company in his or her portfolio. Interestingly enough, these companies have underperformed the market in the 2013 version of "the Fed rally."
Year-to-date, the Dow Jones Index is up by 16.5% and S&P 500 Index is up by 14.9%. During the same period, Exxon Mobil (NYSE:XOM) is up by 6.5%, BP (NYSE:BP) is down by 0.9%, Chevron (NYSE:CVX) is up by 12.2%, Total (NYSE:TOT) is down by 5.8%, Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B) is down by 7.4%, Statoil (NYSE:STO) is down by 17.1%, Phillips 66 (NYSE:PSX) is up by 10.6%, Valero (NYSE:VLO) is up by 1.2%, Marathon Petroleum (NYSE:MPC) is up by 10.2%, Petrobras (NYSE:PBR) is down by 37.7%, and ConocoPhillips (NYSE:COP) is up by 8.3%. Pretty much every major oil company has been beaten by the market. One would think that oil price must have been down, but we don't see that happening either. Since the beginning of the year, average oil price has been around $95, which is well-above the historical averages.
Not only have oil companies been underperforming the market, but they continue to have low valuations compared to the market. Most major oil companies currently trade for single-digit P/Es (more on that later), whereas the average P/E in S&P 500 index is 15.49.
When evaluating value of companies, there are several metrics one could look at. Some of the most important metrics are: price to sales, price to trailing and forward earnings (including and excluding cash), price to book value, dividend yield and price to cash flow ratio. Having said that, it is important to look at these companies beyond these numbers though. For example, one company might have very strong fundamentals but it might be in the middle of a lawsuit that has the potential of draining all or most of its cash reserves (hello BP?).
In the table below, you'll find the current valuations of each major oil company. When we look at trailing price to earnings, we see that BP, Valero, Marathon and Statoil are exceptionally cheap. ConocoPhillips, Total and Exxon Mobil look like they are more expensive than their peers, even though these companies are still cheaper than the market by a large margin (remember that the average P/E in the S&P 500 index is above 15).
If we look at price to book ratios, we see that Petrobras is insanely cheap. After Petrobras, we see Valero, Total and Statoil. For reference, the average price to book ratio in the overall market is 2.3. All major oil companies with the exception of Exxon Mobil have price to book ratio that is below the market's average.
When we look at price to sales ratio, we also see similar trends. Compared to the S&P 500 average of 1.5, all oil companies are undervalued. When we compare the price to sales and price to earnings ratios, we see that the oil business has low margins across the board, even when oil price is near $100 per barrel. This is because companies tend to invest a lot of their earnings for oil exploration and development. In other words, most of the current earnings in the oil industry are being spent to ensure the future earnings.
Our next metric is price to cash flow, and Petrobras, Statoil, Valero and Marathon strike me as the cheapest companies in this category. Exxon Mobil is on the higher side of things due to expensive investments made by the company; however, even this company falls far below the market average of 9.9 (the industry average is 5.5 for oil companies).
Finally, when we look at the dividend yields, BP, Statoil and ConocoPhillips appear to be winners. Keep in mind that Norway will withhold taxes from Statoil's dividend. Also, keep in mind that Statoil's dividend payments are not as stable as other oil companies, even though the company is strongly committed to returning value to shareholders consistently. The company's dividend yield will range moderately from year to year. Companies like Exxon Mobil have lower yields, but they have stable payments with consistent growth over years.
Price to Earnings
Price to Book
Price to Sales
Price to Cash Flow
Royal Dutch Shell
When we look at future valuations, which should matter more for investors, since investment is future oriented, we see Valero, Statoil and Petrobras as the best valuation plays.
Royal Dutch Shell
Basically, across many metrics, Valero, Petrobras and Statoil look like the best-valued oil companies. We will have to look beyond the numbers to see a better picture though.
Looking Beyond Numbers
While it enjoys strong valuation, Statoil has been dealing with some issues lately. Apparently, the company failed to report a leak on the seafloor, it has to deal with high operating costs in Norway and hopes that the government of Norway will not raise the already-high oil taxes further in the country, and the company is also being sued for price-fixing along with a couple other major oil companies. Petrobras has its own share of issues to worry about. Brazil's economy is weakening and its currency is losing value as the inflation hits the country hard. Also, the fact that Brazil's government has been interfering with the company's business is not helping either. Many investors are worried that the government will end up nationalizing the oil company, effectively wiping out the investors. Valero seems to have a lower risk profile compared to Petrobras and Statoil.
Having said that, I currently own shares of Statoil. In the past, I used to own shares of Exxon Mobil, BP, Chevron, Total, and Royal Dutch Shell. The data I presented could be interpreted in more than one way, and different investors may reach different conclusions. It looks like the oil industry is very cheap as a whole and it's been underperforming a market that's been rallying relentlessly. At this point, it may be a good idea to buy shares of some oil companies.