Five Plays In The Beaten Down Energy Sector

Sovereign debt worries in Europe are causing global economic growth trends to slow. This is bad news for the energy industry, which thrives when the business cycle is in full swing and demand for its oil, natural gas, and refined products, including fuel and industrial chemicals, is high. But in an attempt to buy low and sell high when market conditions improve, now might be a good time to consider investing in market leaders with reasonable valuations. Below are five stocks that present enticing plays in the beaten down energy sector.

Royal Dutch Shell (RDS.A)

International integrated energy giant Royal Dutch Shell has spent the past few years boosting its production base and cutting costs. This strategy is paying off for shareholders who have seen a steadily increasing dividend payout since 2006. Royal Dutch’s current dividend yield on its class A common stock is 4.7%. This is well above the current overall stock market yield of 2.2%. Its class B shares further emphasize a payout of capital and sport a current yield of 5.3%. These yields are well above the market but also ahead of most other players in the energy space. Analysts project only modest sales growth of a couple of percent over the next few years, but the current year’s profit projection is $8.47 per share and puts the forward earnings multiple in very reasonable territory at right around 8 [for more energy news and updates subscribe to our free newsletter].

Chesapeake Energy (CHK)

One of the more controversial energy stocks in recent months has been Oklahoma-based Chesapeake Energy. Chesapeake is almost exclusively tied to the U.S. energy market, and natural gas in particular. It is even credited with helping lead the charge to horizontal drilling techniques, including the controversial but lucrative hydraulic fracturing, or “fracking” that is used to bust up shale rock and release natural gas and related gas liquids. Its main problem is investments to build out future production capabilities were based on much higher natural gas prices. The company has had to work quickly to ramp down production spending to match its shrinking cash flow. A hefty debt load has only served to exacerbate the problem.

Bankruptcy risk is minimal, but always a potential for a firm that likes to be aggressive. The fact that high profile investors, including Carl Icahn and value investor Mason Hawkins, are owners is comforting, as is a stock price that is well below the value of its energy and production assets. Place this stock in the high value, high risk category [see also The Ten Commandments of Commodity Investing].

Phillips 66 (PSX)

Phillips 66 is a recent spin out from energy giant ConocoPhillips (COP). ConocoPhillips has decided to take a different route from its peers and divide up its exploration and production assets from the refining ones. Phillips 66 houses the refining, marketing, midstream and chemicals businesses that used to be part of the parent company. It now qualifies as the largest independent refiner and is actually seeing strong profit margins due to the difference between the energy it must purchase but can then sell the refined fuel in the market.

Spinoffs also have a track record of outperforming the market because the new management team is freed up to control its own destiny and pursue growth that a former parent might not have allowed. Analysts project almost $200 billion in revenues this year and solid profits of $5.23 per share. At a recent share price below $40, the forward P/E is therefore appealingly low at around 7.4 [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].

Apache Corp (APA)

Firms such as Chesapeake and Phillips 66 are driven predominantly by trends in the U.S. energy market. This works when domestic conditions are favorable, but the drawback is that their operations can suffer during a downturn in natural gas and oil prices, such as is occurring currently. Apache Corp’s value proposition is its balanced approach among differing energy arenas and geographic diversification. For instance, while Chesapeake hustles to ramp down its capital expenditure needs due to low U.S. natural gas prices, Apache only counts on the United States for about 40% of its annual production. The aggregation of Egypt, the North Sea, Australia and Argentina account for 45% of production, with Canada making up the rest.

This balanced approach flows through to Apache’s management style. It generally keeps its capex needs below the cash it generates annually. Debt is also among the lowest in its peer group. This balanced, disciplined approach has resulted in annualized production of 13% since 1992. This has translated into similar levels of sales and profit growth in recent years. For the full year, analysts project more modest sales growth of 4.4% and profits of $10.70 per share. This puts the forward P/E in bargain-basement territory at below 8 [see also The Five Minute Guide To Oil ETFs].

Exxon Mobil (XOM)

As one of the largest and most diversified firms in the industry, energy giant Exxon Mobil has something to offer nearly every investor. Its current dividend yield is 2.6%, which also exceeds the current overall stock market yield. More importantly, its management team has a reputation as one of the savviest and most successful capital allocators in the business. This is key in an industry that requires upfront investments as high as in the billions of dollars and for projects that can take many years to build out before they start seeing a return on their investment.

Exxon Mobile recently saw its earnings hit by record-low natural gas prices and total production fell 5.5% from the previous year. However, earnings rose by more than 50% to $15.9 billion, which benefitted from asset sales. Analysts project a slight sales decline of 4% for the full year and total sales of almost $470 billion, but steady profit levels of nearly $7.60 per share. This puts the forward P/E in very reasonable territory at right around 11 [see also 25 Ways To Invest In Crude Oil].

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Disclosure: No positions at time of writing.

About Ryan Fuhrmann

Ryan Fuhrmann, CFA, is a freelance financial writer and investor. He settled on a pursuit of investing after taking a class entitled "Security Analysis" while at the University of Wisconsin-Madison and has since adopted a value-based philosophy toward the markets. His work and interviews have been quoted in the press and investment publications including "Barron's" and local business journals. Ryan is also an advisor to Butler University's student managed investment portfolio and co-hosts the Smart Money Show on Saturday mornings on Freedom 95.9 WFDM in Indianapolis.
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