Energy stocks are on an uptick in the face of recent supply concerns and alleviated demand-side skepticism. Energy companies substantially underperformed the market in 2019. Investors and traders have been crushing shares of energy stocks as they price in estimated oil price declines, but have these shares been oversold?
Investors are beginning to think so, as the global economic outlook brightens, and concerns about declining demand are eased. Oil prices have rallied 20% since the beginning of October to their highest level in 8 months. Oil bears are beginning to leave the market and opening up buying opportunities for the most prudent energy stocks.
The 2019 energy bust was driven by demand-side concerns with little focus on supply. Investors and analysts were concerned about global geopolitical issues like the US-China trade war, Brexit, and negative interest rates. Now demand concerns are abating, and supply uncertainty is taking center stage as tensions in Iran heighten. Following the US’s assassination of one of Iran’s top generals, the country has called for revenge, and oil companies in the region appear to be a likely target.
Exploration & Production (E&P)
This segment is known for its volatility, and with demand outlook looking dim throughout 2019 shares of our favorite E&P got hammered. These stocks are finally seeing the light of day.
EOG Resources (EOG)
This stock is the largest player in the space and provides an excellent long term investment at its current valuation. Investors are finally realizing the opportunity of this undervalued equity and have driven this stock up over 18% in the past 30 days. Despite its negative performance, EOG has been able to substantially outperform its industry in the last 52-weeks (as shown below).
EOG has demonstrated reliable cash flows along with a robust growing dividend. EOG is sporting a price/cash flow of 5.8x, which is on the lowest end of its 5-year range of 4.5x to 27x.
Diamondback Energy (FANG)
I believe that Diamondback is a diamond in the rough. The firm has been able to exhibit almost exponential topline growth with year-over-year expansion in the high double to triple digits. FANG stumbled following its weak Q3 earnings at the beginning of November but has since been on the upswing.
This company is riskier than EOG due to its volatile free-cash-flows. Diamondback consistently produce growing cash flows from operations, but this cash is often eaten up by Cap-Ex and dividend payouts. The firm is demonstrating debt to total capital of 23.5%, which gives me some comfort concerning its financial flexibility.
This stock is trading at the lowest end of both its price to cash-flow and P/E metrics. FANG’s forward P/E is trading at 10.9x, a substantial discount to the broader E&P market average of 18.6x.
21 out of 22 analysts are calling this stock a buy right now with an average upside of 33% from what it is trading at today.
Integrated Energy Companies
Integrated energy firms are a much safer bet on the space as they are self-hedged. These companies enjoy economies of scope as they own all aspects of the value chain from production to your gas tank. Stocks in this segment typically yield investors a hefty dividend
CVX is my integrated pick. The company has recently completed some mega-projects, including an LNG facility in Australia. Its capital spending is now down to normalized levels and can sit back and reap the benefits of above-average production growth (3 – 4%).
Chevron has been able to produce free-cash-flows that far surpass its closest rivals, giving it flexibility for high NPV projects, dividend expansion, and continued stock repurchase.
CVX has outperformed its space over the past 52-weeks (as you can see below), and I expect this to continue as its calculated management team continues to achieve operational excellence.
CVX yields investors a robust 4% dividend and is repurchasing shares at a pace of $1.25 billion quarterly.
11 of 13 analysts are calling CVX a buy right now with an average target price that would represent a 16% share price appreciation from what it is trading at today.
Oil is entering a bull market with this volatile commodity rallying 20% since October. Traders and investors are starting to see that the energy sector is trading at a discounted valuation. The industry has rallied hard since the beginning of December. Now is an excellent time to jump into energy’s best-positioned equities before their cheap valuations disappear.
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