It is understandable that many investors are feeling rather uncertain about investing in the oil and gas sector. After all, the outlook for the price of oil continues to be pessimistic and, according to various experts, it is unlikely that it will get anywhere near $100 per barrel over the medium term.
The key reason for this is a global supply/demand imbalance that is showing little sign of changing. In fact, OPEC recently announced that it is continuing with its strategy to maintain current levels of production and that it believes it will ultimately be successful at hurting higher cost producers.
Valuations
Of course, the low oil price has caused profitability to fall, assets to be written down and share prices to come under severe pressure for companies in the oil and gas sector. And, while the current trend may continue over the short run, for longer-term investors it presents an opportunity to buy stocks at appealing prices.
For example, Woodside Petroleum Limited (ASX: WPL) now trades on a price to earnings (P/E) ratio of just 11.8, which is considerably lower than the ASX's P/E ratio of 16.7. As such, it could be argued that an upward rerating could be on the cards – especially since Woodside has superb financial strength and excellent cash flow, thereby meaning that its chances of coming through the challenging trading conditions are relatively high.
Earnings
However, Woodside's bottom line is expected to fall by over 50% during the next two years, and so investor sentiment could be hurt in the short to medium term. Clearly, this is largely due to a lower oil price and, while sector peers such as Santos Ltd (ASX: STO) are experiencing similar challenges, there is growth potential on offer.
In fact, Santos is forecast to increase its bottom line at an annualised rate of 20.4% during the next two years. This means that, while the company has a P/E ratio of 17.3 at the present time, its price to earnings growth (PEG) ratio is just 0.84. This indicates that Santos offers growth at a reasonable price, and that its growth outlook could be the catalyst to push its share price higher.
Certainly, its real potential remains longer term, with global demand for liquefied natural gas (LNG) set to exceed supply in the 2020s. However, Santos seems to be performing relatively well right now and, while its bottom line will inevitably remain volatile, its valuation indicates that the margin of safety is somewhat generous. This point is further evidenced by Santos' price to book (P/B) ratio of 0.83, which is much lower than Woodside's P/B ratio of 1.51.
Looking Ahead
So, while Woodside is a high quality stock that remains an appealing buy at the present time, Santos seems to offer a clearer path to capital growth for its investors. Certainly, forecasts will inevitably change, but its valuation indicates that Santos' share price could reverse the 45% fall of the last year in the medium to long term, with its earnings growth being the clear catalyst for improved investor sentiment.
