Investors need to tread carefully when investing in what are generally perceived to be bombed-out sectors. Indeed, a quick look at the 12-month chart below clearly demonstrates the ups and(mainly) downs of the embattled companies unfortunate enough to be exposed to the price of oil some more than others
However, for those brave enough to venture into this sector, the rewards could be transformational to their portfolio. Of course, the opposite would be true should the price of oil slump further again, I would point to the chart for the risks involved here.
A question of balance
With these parameters in mind, I believe that a bar bell approach could well serve prospective investors well whilst venturing into this sector.
If it was my money on the line I would want to equally weight my selection, but given the three companies that Ive picked BP (LSE: BP), Plexus Holdings (LSE: POS) and Premier Oil (LSE: PMO) I wouldnt be looking to allocate an equal weighting in each company. Personally, Id allocate 50% to BP and 25% to Plexus and Premier respectively.
The rationale behind this is two-fold. Firstly, the main part of your holding is in a mature, diversified, dividend-paying company, which as you can see from the chart has fared rather better than its smaller, more specialised energy sector peers, This company should offer some downside protection should the price of oil slip further. Secondly, whilst we can say with a degree of certainty that BP isnt going to shoot the lights out, should the oil price begin to recover, I would expect a much more pronounced recovery in the price of the smaller Premier and Plexus, whichare more exposed to the price of oil due to their more specialised operations.
Lets take a look at the three companies in turn.
BP announced its results earlier this week, which beat expectations always nice thing to do! Additionally, CEO Bob Dudley set out to reassure investors that the dividend was safe, even if there was further and sustained oil price weakness.
Furthermore, the company continues to rationalise its portfolio, and further divestments and cost cuttings are expected this year through to 2017.
We have to be a leaner, fitter company, and simpler to operate, Mr Dudley said.
On Wednesday, we saw results from Plexus Holdings. I have to say that I was rather impressed with the performance of this company, which is engaged in marketing a patented method of engineering for oil and gas field wellheads and connectors, named POS-GRIP, which involves in deforming one tubular member against another within the elastic range to affect gripping and sealing.
The headlines looked good:revenue +5.6% to 28.53m; profit before tax up 10.5% to 5.94m; and the final dividend increased by 182.3% to 1.75p that suggests confidence in the future to me!
Management flagged that the outlook was still challenging, particularly in the North Sea; however, over the longer term they see prices set to recover and further adoption of their proprietary offering within the industry.
Finally, some might say the dog of the trio in my view could well be a promising recovery play once the price of the black stuff stabilises. In its most recent update, management advised investors that banking covenants had been relaxed, capex had been reduced to an expected $500m in 2016 and the company had also secured a $92 price tag for around 60% of its expected H2 production, and $68 for around 30% of its expected 2016 output.
The company currently trades on a rather scary forecast price-to-earnings ratio of over 50 times earnings. However, although I fully expect plenty of volatility going forward, once the oversupply issue is resolved I believe that Premier could well deliver outstanding returns to those brave enough to invest.
The Foolish Bottom Line
One of the main issues currently depressing oil prices is the fact that there is still considerable oversupply in the market; however, once this works through, Id expect to see the price stabilise and in time increase.
Whilst you wait, BP currently offers a near 7% yield thats twice the median forecast dividend yield of all dividend payers in the market!
Should you be an investor with an eye on income and want to avoid your fingers being cut by this and other falling knives, take a look at this report containing The Motley Fool’s very own Mark Rogers’Five Golden Rules for Building a Dividend Portfolio, within this special free report entitled:“How To Create Dividends For Life”
This report will show you how to tailor your portfolio, allowing you to ‘Dividend and Conquer’ — and lay the foundations of a more dependable income-focused portfolio. It’s currentlyFREE and comes without obligation. So, sit back in your favourite chair,click hereand enjoy!
Dave Sullivan has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.