There’s 'substantial’ value in these two Big Oil stocks, Morgan Stanley says

Published Tue, Apr 27 20216:09 AM EDTUpdated Thu, Apr 29 20216:00 AM EDT

Lucy Handley @in/lucy-handley-b2b0a61a/@lucyhandley

Analysts at Morgan Stanley have picked global oil stocks that they believe are set to outperform the wider market in the next 12 months. While U.S. oil firms have generally done better than the European majors in 2021, firms in Europe have a 12-month free cash flow yield of almost double their U.S. counterparts, Morgan Stanley said. A higher cash flow yield is attractive to investors because it indicates a firm is better placed to pay debts and dividends. "European majors have usually been valued at a discount, but the gap is historically wide at the moment," the analysts wrote in a research note last week. "European majors have a substantial latent value," they added, and picked the following two stocks: Morgan Stanley picked Shell as it thinks its payout ratio and therefore dividend growth is set to rise. "At this stage, there is little indication from management in this direction, but when the balance is sufficiently degeared, we think that a period of DPS (dividend per share) growth above the current guidance of 4% pa is likely, which we suspect will be a catalyst for the shares," the bank's analysts stated. "Degearing" refers to a company changing its capital structure by replacing debt with equity. Morgan Stanley estimates a dividend growth of around 10% per year between 2022 and 2025 for Shell. The bank's second pick is Italian firm Eni , which Morgan Stanley says is likely to spin out a combined retail and renewables business. "Hiving out a New Energy business can unlock a large amount of value," the bank's analysts wrote. "The balance of earnings upgrades vs share price performance has left the valuation gap between European and U.S. majors historically wide," Morgan Stanley's analysts stated. "Between 2008-2018, European and US majors traded on nearly identical FCF (free cash flow) yields. However, in recent years a gap has opened up that has widened steadily. By now, European majors have a 12-month forward FCF yield of ~12.6%, approaching double the yield of 7.3% that US majors are valued on," the analysts added. The bank is "overweight" on both Shell and Eni, meaning it expects the stock's total return to outperform the market over the next 12-18 months.

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Analysts at Morgan Stanley have picked global oil stocks that they believe are set to outperform the wider market in the next 12 months.

While U.S. oil firms have generally done better than the European majors in 2021, firms in Europe have a 12-month free cash flow yield of almost double their U.S. counterparts, Morgan Stanley said. A higher cash flow yield is attractive to investors because it indicates a firm is better placed to pay debts and dividends.

"European majors have usually been valued at a discount, but the gap is historically wide at the moment," the analysts wrote in a research note last week.

"European majors have a substantial latent value," they added, and picked the following two stocks: