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All Contents © 2020The Kiplinger Washington Editors
By James Brumley, Contributing Writer
| June 6, 2018
The more-than-doubling of crude oil prices over the past couple of years has been a difficult rally to trust. Energy companies still aren’t exactly highly disciplined outfits despite the pain of overproduction they inflicted on themselves back in 2014.
On the other hand, the bears have had every opportunity to upend the rally but have been unable to do so. Perhaps a price of more than $60 per barrel really is the “new normal” for the energy market. At the very least, investors would be wise to respect that not investing in energy stocks could be riskier than being in them for the foreseeable future.
Until there’s a clear sign of trouble for the slippery commodity, here’s a run-down of 10 top prospects to play energy’s normalization. Some of these energy stocks are familiar, while others are a bit off the radar. Still others border on being outright unknowns.
In all 10 cases, however, there is outsize opportunity for oil-driven upside.
Data is as of June 5, 2018. Dividend yields are calculated by annualizing the most recent quarterly payout and dividing by the share price.
Market value: $234.1 billion
Dividend yield: 3.6%
Don’t be surprised that energy powerhouse Chevron (CVX, $122.73) is not just on a list of energy stocks to buy, but batting leadoff. It’s almost painfully cliché. But there’s a reason Chevron is one of the biggest, and arguably the best, name in the business: The company is good at what it does, and it has staying power.
Investors have forgotten this at times, of course. CVX took its lumps like all other energy stocks did in 2014 and 2015, with investors unsure whether the industry and even its biggest players would survive as we know them. Chevron shares’ sizeable pullback in late January and early February of this year, however – a 16% tumble from peak to trough – made a little less sense.
The move did, however, lower the price of CVX shares to make them an attractive, straightforward and simple opportunity now. Revenue still is expected to grow 20% this year, driving a more-than-doubling of the company’s per-share profits.
Chevron’s a particularly compelling energy pick for dividend fans. CEO Michael Wirth explained at the annual shareholders meeting held just a few days ago, “Chevron’s first financial priority is maintaining and growing the dividend,” adding “In January, we announced a four percent dividend increase, putting us on track to make 2018 the 31st consecutive year of increased annual per-share dividend payout.”
Market value: $21.8 billion
Dividend yield: 0.6%
Neuberger Berman senior research analyst Todd Heltman is broadly bullish on the oil industry’s exploration and production companies. He specifically notes that Devon Energy (DVN, $39.32) “has significant catalysts ahead including a large non-core asset sale program in which proceeds will be used to further pay down debt, buy back stock and raise the dividend.”
Those divestures were first announced roughly a year ago, with total proceeds projected at around $1 billion at the time. The effort started slow but has picked up plenty of speed in the past few months. In March of this year, Devon announced the impending sale of a huge piece of its Barnett Shale project for more than half of a billion dollars. But just a couple of weeks later, Devon said it may sell up $5 billion worth of properties that are distracting it from its Permian and Rocky Mountain projects.
For perspective, Devon Energy was only sitting on $9.6 billion in debt as of its most recent quarterly report; $5 billion in cash could pay down a huge part of its indebtedness. Granted, those assets on the proverbial chopping block are also revenue-bearing properties, and shedding them could crimp the top line. Streamlining rather than adding leverage is arguably the better move now, however.
Market value: $95.0 billion
Dividend yield: 2.9%
Although it’s not an oil explorer or refiner, oilfield services giant Schlumberger (SLB, $68.46) still is very much subject to the ever-changing price of oil. And, with crude holding the line at a price above $60 a barrel, the industry increasingly is getting comfortable with the idea of hiring the outsourced help Schlumberger offers.
Indeed, we were already seeing glimmers of that growing demand during the first quarter of the year, even before crude prices ran to new multiyear highs in May. Revenue was up 14% year-over-year, and net income grew a whopping 88% as the company managed to pair expense control with growing demand.
CEO Paal Kibsgaard sees a bright future as well – not just a few weeks down the road but several months down the road. He commented with last quarter’s report, “After three consecutive years of dramatic underinvestment in global E&P spending, the worldwide production base has started to show the anticipated signs of weakness with noticeable year-over-year production declines … It is, therefore, becoming increasingly likely that the industry will face growing supply challenges over the coming year and a significant increase in global E&P investment will be required to minimize the impending deficit.”
Market value: $2.3 billion
Dividend yield: N/A
Jagged Peak Energy (JAG, $10.87) is anything but a household name. With a modest market cap of only a little more than $2 billion, the independent oil and gas explorer just doesn’t turn many heads.
That doesn’t mean JAG isn’t worth owning – at least to investors who can look past recent fiscal volatility and appreciate that Jagged is a work in progress.
Jagged Peak Energy booked a loss of $39.4 million last quarter. Read the fine print, though. On a non-GAAP/operating basis, the company turned a profit of $26.4 million on a year-over-year production improvement of 182%. During the quarter, Jagged Peak bored 12 new horizontal wells and brought online eleven other wells spud during the prior quarter, making good on several quarters’ worth of investments.
This still isn’t a stock for the faint of heart. However, for investors who can digest the idea that you own JAG not for where it is but where it’s going, the current quarter’s projected 14% improvement in the prior quarter’s output speaks volumes. All told, Jagged Peak Energy has identified more than 2,000 potential wells spread across the 77,700 acres it has leased. That means it has barely even scratched the surface of its total prospects.
Market value: $32.2 billion
Dividend yield: 0.1%
The market is full of established, familiar exploration and production companies. Pioneer Natural Resources (PXD, $191.16) isn’t one of them. This is an independent E&P company, which has helped keep it off most investors’ radars, for better or worse.
Don’t let its obscurity fool you, though. Pioneer has turned $5.3 billion worth of revenue into net income of $827 million over the past four quarters. That’s respectable, even if it’s not stellar.
Investors should consider a few other points, too. For instance, Pioneer’s balance sheet is oddly devoid of debilitating debt. It has only $900 million in debt – a pittance for a company of its size compared to its peers – and stronger-than-expected oil prices have supplied far more cash flow than the company was expecting this year.
Second, Pioneer Natural Resources is becoming hyper-focused on Permian assets and is shedding properties outside of the Permian Basin. The geographic concentration will not only lower transportation costs, but the oil and gas trapped in this part of Texas and New Mexico means the company’s breakeven costs could slide even lower than their current levels at $58 per barrel.
Market value: $66.7 billion
Last quarter’s earnings presentation from EOG Resources (EOG, $116.58) was rich in reasons that indicate the company is tops among the energy sector in terms of results. Admittedly, it’s a self-serving message. On the other hand, EOG CEO Bill Thomas wasn’t exactly wrong when he cited specific details during that conference call that make his company stand out.
Like Pioneer Natural Resources, EOG Resources is an independent explorer and producer. Unlike Pioneer, EOG is geographically diversified, with operations all over the United States and as far east as China, and with a couple big projects in between here and there.
It’s not mere hot air when Thomas said the company knows the shale business as well as anyone, if not better than anyone, in the business. EOG has been doing horizontal drilling since before the word “fracking” was used in polite company, and new technologies like its Conan oil-gathering system pre-solves the problem of a limited number of pipelines from the Permian Basin.
More than anything, though, EOG is unique in the sense that it’s still prioritizing profitability rather than scaling up total production at almost any cost.
Market value: $37.1 billion
Dividend yield: 3.4%
There’s more than one good way to make money in the oil business. Rather than drilling or refining it, one can simply ship it from one point to another, charging a small fee for every barrel that passes through a pipe. Think of them as the energy industry’s tollbooths.
Enter Kinder Morgan (KMI, $16.84) – one of the sector’s biggest distribution players, sporting 85,000 miles of pipelines stretching across a huge swath of North America, accessible via 152 terminals. It can ship and store anything drillers can extract and anything refiners can prepare for use. Better yet, pipeline operators aren’t nearly as subject to wild swings in oil and natural gas prices as explores and producers are (though they still often move with energy prices). The cost to deliver crude and gas through a pipeline is relatively stable, as is the price at which such a service can be sold.
One nuance makes Kinder Morgan a particularly interesting opportunity right now. That is, after years of unsuccessful efforts to clear regulatory hurdles that would let it expand its Trans Mountain pipeline in Canada, it’s finally backing off … and will pocket $3.5 billion by doing so.
That cash hasn’t yet been earmarked for anything in particular, but that’s not the point. The point is, the company’s about to get 3.5 billion ways to invest in future growth and profitability.
Market value: $63.0 billion
Dividend yield: 5.8%
Enterprise Products Partners (EPD, $29.50) isn’t a household name, but maybe it should be. At least for investors.
Lyn Alden, founder of Lyn Alden Investment Strategy, writes that EPD “is one of the largest integrated midstream energy companies,” adding it has “50,000 miles of natural gas, NGL, petrochemical, and refined product pipelines and dozens of major processing, exporting, and storage facilities.”
Enterprise Products Partners is also, as the name suggests, a partnership – an ownership/oversight arrangement that’s well suited for dishing out cash flow created as natural gas and crude oil is pumped through its pipes. But, it’s also an arrangement with some tricky tax implications to consider.
The special-handling is worth it though, particularly when it comes to Enterprise Products Partners. Lyn Alden, founder of Lyn Alden Investment Strategy, says, “The partnership eliminated its incentive distribution rights years ago, which gives it a lower cost of capital than most other MLPs. Most of their debt is fixed rate with yields below 5%, and they maintain a low level of leverage relative to the rest of the industry, which buffers them against rising interest rates. Most importantly, by gradually reducing its distribution payout ratio, EPD will become self-financing later this year, meaning that unlike most MLPs they will not be reliant on issuing new units to fund future growth and will instead be able to grow entirely with internal capital and attractive financing.”
Bonus: Pipeline companies are actually fairly immune to changes in the price of oil.
Market value: $153.5 billion
Dividend yield: 5.2%
BP (BP, $46.29) is arguably the energy sector’s best-known name, but not necessarily for the right reason. The energy giant was pegged as the villain of 2010’s oil spill in the Gulf of Mexico. Although that environmental disaster has been all but abated, consumers haven’t entirely forgotten even if they have forgiven.
Regardless, BP appears to be on the right track now, finding the right balance between spending, sales and demand. Last quarter’s earnings grew 71% year-over-year, with higher oil prices and higher-margin operations both chipping in. Oil output, in barrels, was up 6% for the recently completed quarter.
CEO Bob Dudley knows that the future isn’t just hydrocarbons. He’s willing to invest in alternative energy sources, committing $500 million per year for the next several years to develop or acquire low- and no-carbon options.
It’s a total-package rebound play, with something compelling to offer now and later – an idea that hasn’t gone unnoticed by Harley Kaplan, investment advisory representative at Sherborn, Massachusetts-based advisory Beta Industries. He explains that the “global conglomerate has rebounded from its troubles and has thoroughly diversified its business, paying about 5%+ while providing up and downstream services, plus natural gas exploration and transportation, plus pipelines, processing, transportation and storage.”
“The stock has room to run,” Kaplan adds.
Market value: $52.0 billion
Dividend yield: 2.4%
You may recognize the name Valero Energy (VLO, $123.33) for its chain of convenience stores and filling stations. But the company is so much more than the consumer-facing division. Valero is the world’s largest independent refiner, and it has a respectable operation too. It’s even an ethanol play.
This diversity has helped the organization smooth out some of the rough patches that more focused energy players experienced in 2014 and 2015.
That’s not to say Valero avoided the turbulence altogether. It didn’t. Between 2014 and 2016, annualized revenue was nearly cut in half. The upside of being a supplier to your own gas stations, though – not to mention offering refining services to producers – is that your profitability isn’t entirely dependent on firm oil prices. VLO was able to push its way through the industry’s dark days of a couple years ago without dipping into the red ink. Now income is on the rise again, perhaps as much because of economic strength as because of the firm price of oil and gasoline.
Perhaps even more enticing is a dividend yield of 2.7% that could grow, big-time, if Valero’s per-share profit soars from last year’s $4.96 to next year’s $9.37. That’s what analysts expect.