The global oil and gas industry has been strongly developing over the last months. The production of oil has increased globally hence raising the supply and, consequently, economic and other supply side forces. However, the prices of oil are always at low levels. Some members of OPEC retort that the price of oil may never rise again, and the general populace seems to accept this difficult situation. The problem is that the public assumption is not substantiated and, finally, the prices may increase again. In order to complete this assignment, the oil and gas industry stocks were selected, which include both BG Group PLC and BP PLC and are traded on LSE. In order to rationalise this respective choice, it is necessary to mention the words of Warren Buffet who once stated that an investor ought to be greedy, when everybody else fears, and be fearful when everyone else becomes greedy.
Consequently, according to the selection of BG Group PLC and BP PLC, which is based on Buffet’s famous statement may not make economic and investing sense to anybody. However, it may provide simple and verifiable market observations. At the beginning of this month Royal Dutch Shell PLC made an offer to acquire BG Group PLC at 52% premium price which includes cash and shares of the acquirer. Holding all other factors as constant, the merger appears at the time when the oil industry is suffering from the price setbacks. This can be interpreted as the signalling theory to indicate that the future of the industry may be successful (BG Group 2015). Considering the aforementioned facts, this report presents the ratio analysis about the viability of investing in each of the two companies with a recommendation for the most preferred investment at the end.
Brief on the Two Companies
BP PLC is a main market FTSE 100 oil and gas producer trading in the FTSE subsector of integrated oil and gas in the LSE. The company is registered in Great Britain and has been a critical contributor to the oil and gas supply industry globally. This means that in addition to the fact that it has been contributing to this sector globally, the company has been affected by the external problems of dipping oil prices due to the strengthening of dollar and increased production of energy by fracking of shale oil in the US. In the recent years, the financials of the company have reflected the heat that the company has been taking from the volatility of oil prices. The revenue of the company has been decreasing every year from December 2011 to the most recent report in December 2014, when they recorded 227161.64 £ million. This was a drop from the 2013 figure which stood at 229918.74 £ million. The EPS was at 13.20p in 2014 having decreased from 75.21p in 2013 while the PE rose to 31.14 in 2014 from a low of 6.50 in 2013. These ratios will be discussed in more details in the next section. The company may require to position itself strategically in order to protect itself from the occasional problems faced in the oil and gas industry.
BG Group PLC operates in the same industry as the BP PLC. However, the performance of both companies appears to be different in absolute terms indicating that their fundamentals are also different. The revenues for this company have been slowly increasing over the last four years beginning from a low amount of 11,367.99 £ million in December 2011 to a high number of 12,392.87 £ million in December 2014. The EPS of the company dropped slightly to 76.07p in 2014 from 77.99p in 2013. On the other hand, the PE dropped to 11.37 in 2014 from the high amount of 16.64 in 2013. The company is in a merger negotiation deal with Royal Dutch Shell PLC in which the acquirer is offering cash and shares at a premium of minimum 52% going by the price of the company on the date when this deal was announced. The above mentioned ratios will be discussed in the next section. However, BG Group PLC seems to have found an appropriate way of improving their situation by considering the merger with Royal Dutch PLC. Moreover, as it may be noticed throughout this report, the company is one of the favourite competitors discussed, and there is no reason not to invest in it before the merger deal is signed (BG Group 2015).
Comparative Ratio Analysis
This section will deal with the analysis of the financial ratios for both companies. It is worth noting that the ratio analysis gives a comparable preliminary review of the performance and operating fundamentals of the company, but it is critical for this specific analysis because it takes the investor’s perspective. The analysis will begin with every investor’s favourite and the price of earnings (PE) atio. Other invest ratios of interest will be the earnings per share and the dividend yield ratios. Regarding the profitability ratios, the analysis will focus on the return on assets (ROA), return on equity (ROE), and the return on invested capital.
The price of equity ratio stands as the favourite one for every investor due to the fact that it ensures a direct answer to the buy-low and sell-high theorem (Brigham & Ehrhardt 2014). It provides the information regarding the issue whether the company generates enough earnings commensurate with its market valuation, thereby answering the question how much time will be required by an investor to recoup his investment capital. There exists an opinion that, the shorter is the duration, the better will be the investment (Brigham & Ehrhardt 2014).
Concerning BP PLC, the PE stood at 31.14 in 2014 as compared to the low of 6.50 in 2013. This means that the investor will require at least 31.14 years to recoup his invest in the company if he buys the company’s shares (Ross 2015). A review of the company’s share price by the time of this report indicates that it was trading at the 470.95 with the trading graphical simulation showing that the price is likely to continue with its bullish trend over the next weeks. Whatever is driving this price upwards, it may be mere speculation that the company will report better earnings in the first quarter of 2015 as compared to a similar period in 2014. However, the company is set for a rough ride because the oil prices indicate no signs of improvement, unless the investors speculate that the war in Yemen will create some oil shortages, which will raise the demand and the prices. However, the PE increased by 24.64 between 2013 and 2014 indicating that the share is more expensive than ever to purchase at the moment (London Stock Exchange 2015). The reality is that the company must improve its earnings more rapidly in order to keep the price at the current level. Moreover, if they fail to implement this plan, the price will dip again in the next few weeks and the investor would not accept such a failure. (London Stock Exchange 2015).
Considering this situation from another perspective, the PE of BG Group PLC stood at 11.37 in 2014 having dropped from a high of 16.64. According to these numbers, the investor may calculate that it would only take 11.37 years for him to reimburse his money if he purchases the shares at the current price ranging between 1173.00 and 1184.89 (London Stock Exchange 2015). The PE improved over the years despite the fact that the company had the same predicaments that affected the oil and gas industry as well as by interpretation that the company’s share was 19.77 times cheaper than that of BP PLC. An investor would also be interested in the earnings per share ratio. This ratio represents the portion of the firm’s profit after tax that gets allocated to each unit of the outstanding share (Brigham & Ehrhardt 2014). Consequently, the higher is the EPS the more attractive is the investment since it indicates that there are increased earnings and better financial position of the company. As stated above, the EPS of BP PLC stood at 75.12p in 2013 before dropping to 13.20p in 2014 (London Stock Exchange 2015). Moreover, such price decrease may raise concerns of the investor. In essence, a speculative investor would only hope that the share prices do not correspond to the drop in a similar or greater margin as it was the case when the investors understood that the decrease was associated with the general volatility in global oil prices. Moreover, it occurred several years after the gulf of Mexico accident and the recent global financial crises.
While reviewing the EPS of BG Group PLC, the company recorded a slight drop from 77.99p in 2013 to 76.07p in 2014 (London Stock Exchange 2015). The decrease was expected given the global business environment in the oil and gas industry. These numbers are low as compared to the overall volatility, which only means that the company’s fundamentals are strong enough for sustainable development and creation of value for the investors. Coupled with the low PE, the EPS provides another reason for which an investor would choose BG Group PLC over BP PLC (London Stock Exchange 2015).
Some investors put their money in a company that pays dividends. Therefore, it is important to consider the dividend yield (Watson & Head 2013). The dividend yield ratio basically measures the amount of a company’s pay-out in dividends compared to the market price of its share. The bottom line is that a higher dividend ratio is attractive for the investors who are focused on dividends. BP PLC recorded an increase in the dividend yield ration from 4.79% to 5.80% in 2013 and 2014 respectively (Londonn Stock Exchange 2015). The increase occurred despite the fact that the company recorded reduced profits over the years and raised its PE while the EPS is dropping massively. According to this interpretation, the dividend pay-out must have been obtained from the company’s retained earnings and was provided to calm the investors who must have been alarmed by the trend that the company was taking with respect to the global environment in the industry. Considering the position of BG Group PLC on similar measures, the dividend yield also increased from 1.35% in 2013 to 2.08% in 2014. The dividend yield is, however, less than half of that which was offered by BP PLC. However, the pay-out for this company was justifiable, and one may notice that it was not obtained from the retained earnings. According to this reasoning, the fundamental analysis of the facts surrounding the dividend yield ratio for the two companies gives yet another reason for investing in BG Group PLC since it is still an attractive option (London Stock Exchange 2015).
The last three ratios for the two companies include the ROA, ROE, and ROI. The ROE for BP PLC stood at 3.36 (2014) having dropped from 17.98 in 2013 (Morning Star 2015). On the other hand, the ROA was recorded at 1.33, which was still a decrease from 7.67, and, lastly, it dropped to 2.76 from 14.90. Interpreted from the perspective of profitability, the ratios indicate that over the years in question the profitability of the company decreased massively, and the organisation has to put much effort in order to convince the investors that they are sustainable in the midst of the global oil prices turmoil. Revision of BG Group PLC shows that the ROA was 5.97% in 2014 while the ROE was at -3.44% and ROI was at 7.94% (Morning Star 2015). The general view is that the ROA and ROI are higher for BG Group PLC than for BP PLC with the exception of the ROE for which BG Group PLC recorded negative decline. This might be one of the reasons for which the current investors at BG Group PLC are considering the offer from Royal Dutch. However, the company is in a proper position for success whether it merges with Royal Dutch Shell PLC or stands on its own since the ratios indicate that it was minimally affected by the oil prices turmoil as compared to BP PLC (Ross Westerfield & Jordan 2014).
Weaknesses of Financial Ratios as a Tool for This Analysis
As a tool of financial analysis, the application of financial ratios provides adequate information that would aid the investors in making more informed investment decision (Watson & Head 2013). However, there are limitations connected with the use of ratio analysis. The first issue is that the accuracy of financial ratios corresponds to the financial statement and reports according to which the ratios are prepared. This means that there are discrepancies in the preparation and presentation of financial statements. Then, the ratio analysis will also be marred. The second issue is the fact that ratio analysis does not consider the accounting policies and assumption applied by the investigated companies (Ross 2015). Accounting policies and assumptions may result in different estimates for the items in the financial statements. Consequently, ratio analysis will not yield appropriate information in scenarios where the policies and assumptions are different (Poniachek 2013). The third concern in this report is that the applied financial ratios relate to the past information and do not reflect the current situation (Ross Westerfield & Jordan 2014). For example, the first quarter of 2015 has almost finished, and there were many changes introduced over this period, but they were not considered in the ratio analysis. Consequently, ratio analysis may be faulty as the information used was from 2013 and 2014.
Conclusion and Recommendations
According to the analysis of BG Group PLC and BP PLC, the ratios of BG Group PLC indicate that the company is fundamentally better placed for sustainability as compared to BP PLC. This is proved by majority of the ratios assessed including the PE, EPS, dividend yield, ROA, and ROI, which are better than those of the competitor. According to the analysis, such situation is due to the fact that two companies have been operating in the same industry and they have been exposed to the same business operating risks over the period of analysis. Further, this report recommends that an investor should consider investing in BG Group PLC whose shares are currently trading at the price range between 1173.00 and 1184.89 at the London Stock Exchange. The reason is that the PE, for example, indicates that the stock is much cheaper than that of BP PLC and, therefore, the investors are set to obtain high returns as the price adjusts to the market industrial averages.