Investors should buy into the low oil price through Shell or BG in order to secure a dividend yield double that of the current FTSE All Share, according to Alex Wright, manager of the Fidelity Special Situations fund.
Wright (pictured) believes that stocks linked to the oil price have been hit unfairly hard but says there’s already a partial recovery already starting to kick in.
Oil stocks have been a huge area of weakness over the past 12 months, after oil saw a rapid plunge in price from $100 a barrel to just $45. There have been some tentative expressions of the price rising since, but these have not been sustained for very long.
Performance of oil since 23 June 2014
Source: FE Analytics
Wright, who invests with a contrarian/value perspective in the £2.7bn Fidelity Special Situations fund, had previously been bullish on the banking sector but has recently been selling down a weighty stake in HSBC. He thinks the oil sector has a lot more to run however.
“There is a real opportunity in the oil sector today and I have been buying stocks across this sector. Oil is now about a 10 per cent weighting of the fund. The biggest position is the combination of Shell and BG, which make up about 6.5 per cent,” he said.
The key reason Wright thinks the sector is cheap stems from irrational selling by investors over concerns of a prolonged period of lowly priced oil. He does not think this will last.
“If [companies] don't invest in oil fields they decline in production quickly. So when you do see oversupply like you have today you tend to see a cutback in capex and therefore a reasonably quick in terms of the supply-side reduction,” he said.
“We are only 12 months or so into a downturn in the oil price but you are already starting to see now year-on-year declines in global oil production. Firstly from shale but in the 12 to 24 months from the rest of the world as well, so the supply picture is improving.”
“Therefore the current supply/demand imbalance is likely to improve over time. The lower prices have also incentivised higher demand as people use more oil at lower prices. You have some very attractive valuations in these stocks at the moment.”
He thinks BG and Shell in particular offer the best risk/reward because while they have lost a lot of ground in terms of their share price, the former will see a huge boost upon completion of ongoing merger between it and Shell.
Performance of indices over since June 2014
Source: FE Analytics
“The dividend yield on Shell is also extremely high, around 7 per cent today. The cash flow of the company even at reasonably low oil prices of $60, you can cash cover that dividend by 2018 by the time you see some of the Brazilian fields [from BG] ramp up.”
“That dividend is increasing secure with the costs savings than it has been over the last few years when they have not been cash covering its dividend. Additionally, if you see oil above $60, then you could see some quite substantial capital upside as well.”
“If oil doesn’t recover substantially is its dividend is very safe and if it does recover then this is a lot of capital upside as well.”
The latest research from Capita Asset Services’ Dividend Monitor, which forecasts UK companies’ dividends pay-outs, says speculation that Shell may cut its dividend is overblown.
“As the largest dividend payer in the world what Shell does matters for the UK dividend pot more than any other stock. Oil prices are low, and Shell is cutting costs and capex rapidly to preserve cash,” it stated.
“It has not cut its dividend since the Second World War, and even though dividend cover is very low, we expect the company to maintain in dollar terms what it pays to investors. The sterling value will depend on the fluctuation in the exchange rate.”
Wright is one of best known contrarian/value managers, having done well in both rising and falling markets.
His approach to his portfolio revolves around buying out-of-favour companies where he sees a catalyst for constructive change. This can be rapidly implemented or take several years.
Wright has managed the Fidelity Special Situations fund since the beginning of 2014, having taken over from Sanjeev Shah
Since he took over the portfolio has returned 6.43 per cent against an IA UK All Companies sector average of 4.36 per cent while the FTSE All Share gained 2.44 per cent.
Performance of fund, sector and index since 1 January 2014
Source: FE Analytics
The fund has a clean ongoing charges figure of 1.16 per cent.