BP downgraded; 'buy' Shell

There's really been very little to separate BP and Royal Dutch Shell this year, certainly in terms of share price performance. Both are up around 40%. But, while the third-quarter is not typically a needle-mover for the industry, profits this year will be pretty grim, and one analyst has been crunching the numbers for London-listed oil majors.

When results come in during the next week or two, oil & gas analysts at UBS expect the European sector to report third-quarter earnings down 28% year-on-year in dollar terms. In the US it's 52%. However, given how close the sector is to breakeven earnings, the declines look worse than they are, and the broker predicts a 22% quarter-on-quarter increase in net income this side of the pond.

That said, while oil prices were flat on the second quarter, they have almost doubled since January to over $52 a barrel. Brent crude is up 13% in just three weeks, and hopes are high that OPEC and the Russians can agree production cuts in Vienna next month. US stockpiles have also fallen.

Share prices have followed suit, however, and BP is up 41% since early June to its best levels in over two years. Shell has surged by three-quarters from less than £13 to over £22.

And that does mean valuations are now "less distressed," so investment opportunities are "less obvious," according to UBS. BP now trades on about 14 times earnings per share (EPS) estimates for 2017, in line with European majors.

"We are lowering our rating on BP to 'neutral' from 'buy' after strong share price performance, retaining our disciplined approach to target multiples that has largely served us well this year," writes the broker.

However, UBS ramps up its price target to 500p from 445p to reflect an oil price estimate of $60 a barrel. This target implies a dividend yield of 6.5%, suggesting share price upside if oil prices exceed $60 and capital expenditure intensity "is sustainably driven downwards".

Shell is still rated a 'buy', with price target raised from 2,100p to 2,250p. "We believe the potential for cost reduction at Shell is greater and the quality of the development/pre-development portfolio is higher," says UBS, "but we are less convinced of the focus to drive these through than at its closest peers; hence the two balance off."

A strategy day in New York on 8 November could be the next catalyst, with American investors given an update on some of the big local issues.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.