2015 has been a challenging year for investors in both Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL), with their share prices slumping by 9% and 10% respectively since the turn of the year. And, while the near-term outlook for oil and gas prices may be somewhat downbeat, both companies appear to offer great value and upside potential. Which one, though, is the best buy?
Growth potential
On the face of it, Woodside has the potential to make the current depressed commodity price period work to its advantage. For example, it is in the midst of making acquisitions of high quality assets with great potential at relatively appealing prices, such as Apache's assets for $4.6bn. Although it may take some time for such purchases to make a contribution to the company's bottom line, this strategy strengthens Woodside's position relative to its peers and provides it with an improved outlook.
However, in the shorter term, Woodside's financial performance is set to come under considerable pressure. For example, the company's bottom line is expected to fall at an annualised rate of 25.2% during the next two years and, while Woodside may be successfully positioning itself for long-term growth, its nearer term outlook could cause its share price to come under further pressure.
Meanwhile, Oil Search is delivering significantly higher revenue in the current year, as its stake in the Papua New Guinea liquefied natural gas (LNG) project begins to have a real impact on its financial performance. In fact, Oil Search reported recently that in the first three months of the year its top line increased by almost three times versus the same period last year and the company is forecast to increase its earnings by 14.2% per annum during the next two years.
Valuation
Although Woodside trades at a significant discount to Oil Search, with it having a price to earnings (P/E) ratio of 11.7 versus 21.1 for Oil Search, the aforementioned divergence in their financial performance during the next two years makes Oil Search the better value investment. In fact, Woodside's P/E ratio is set to rise to 17 in 2016, while Oil Search trades on a price to earnings growth (PEG) ratio of just 1.49.
Furthermore, with Woodside's earnings on the slide, dividends are due to be slashed so that the company yields around 4.7% in financial year 2016. While this is higher than Oil Search's forward yield of 2.5%, Oil Search has scope to increase dividends at a much faster pace than Woodside, owing to its stronger growth prospects and also a dividend coverage ratio of 2.3 (versus 1.25 for Woodside).
Looking Ahead
Although the outlook for the oil and gas sector is challenging, Oil Search looks set to buck the trend and post excellent earnings growth over the medium term. As such, it seems to have a more obvious catalyst to stimulate share price growth than Woodside, which alongside a great valuation and income growth prospects, makes Oil Search the better buy at the present time.
