Outside of perhaps retail, there has been no sector that has done worse the past few years than energy. The Energy Select Sector SPDR Fund (NYSEARCA:XLE), which owns a broad range of energy stocks, is down 45% year-to-date. It’s off by more than two-thirds from early 2014 highs.
It has been a brutal run. Both natural gas and crude oil prices have continued to head in the wrong direction. Oil futures even briefly went negative in April. The shale revolution has a boon for consumers, and close to a disaster for most producers.
That said, the sector isn’t dead. Despite the growth of electric cars and other energy-saving technologies, oil demand will persist for decades, at least. U.S. producers promise a renewed focus on profitable exploration over “growth for growth’s sake”. And energy stocks are cheap in a broad market that looks anything but.
Risks persist, but there is a case that energy stocks at least have a bounce ahead of them. Investors interested in the sector near the lows have no shortage of choices.
One place to start is with energy stocks whose bull cases stand out from the rest of the sector. These four stocks all qualify.
Each sits in a different area of the industry — and each has distinctive reasons for a bottom-timing buy. Investors need to keep the risks in mind, but sector bulls should at least take a look at these four names:
- Chevron (NYSE:CVX)
- Occidental Petroleum (NYSE:OXY)
- Kinder Morgan (NYSE:KMI)
- Cabot Oil & Gas (NYSE:COG)
Energy Stocks: Chevron (CVX)
One way to play the weakness in energy stocks is to buy diversified large-caps on the dip. The likes of Chevron, Exxon Mobil (NYSE:XOM) and BP (NYSE:BP) all have some level of internal protection against plunging crude prices. Those lower prices hurt profits in the upstream (exploration and production) business — but generally help earnings in the downstream (refining, marketing and retailing) units.
In that group, Chevron far and away looks like the best pick at the moment. Exxon increasingly looks like a strategic mess, and its dividend is at significant risk of being cut. BP, as predicted, already has slashed its payout, and European regulation looms as another risk.
Chevron is facing the same headwinds — but appears on stronger footing. It lacks the increasing management concerns seen at Exxon. The announced acquisition of Noble Energy (NASDAQ:NBL) looks smart, even if Chevron is using CVX stock to pay for the deal. Chevron’s balance sheet is in decent shape, as is the dividend.
For investors who want to nibble on energy stocks, the diversified large-cap names probably are the best place to start. Of that group, CVX stock looks like the best choice.
Occidental Petroleum (OXY)
On the other hand, Occidental Petroleum stock is not for investors who want to nibble. It is not a wise choice for capital that an investor can’t afford to lose. OXY stock is the high-risk, high-reward play among large-cap producers.
The risks are obvious. Occidental made something close to a “bet the company” acquisition of Anadarko Petroleum last year. Amid plunging crude prices, the deal is clearly a disaster. OXY stock has lost more than 80% of its value over the past 18 months. Ironically, Occidental outbid Chevron for Anadarko, showing that sometimes even good managers need to get lucky.
As a result, Occidental is an overleveraged producer predominantly focused on U.S. shale drilling. That is a profile that in recent years has led shareholders to lose enormous sums of money — and often all of it. Chesapeake Energy (OTCMKTS:CHKAQ) and Whiting Petroleum (NYSE:WLL) are just two of the similar companies to have gone into bankruptcy.
The flip side of that leverage is that it leaves OXY stock as one of the biggest winners if crude prices do gain. So after OXY made a big bet in acquiring Anadarko, OXY stock at the lows is a similar type of play.
Energy Stocks: Kinder Morgan (KMI)
Midstream operators that transport oil and natural gas are supposed to be less susceptible to fluctuations in the value of the commodity they move. After all, for a pipeline operator, what matters is volume, not price.
Of course, volume and price aren’t independent, as we have seen in recent years. Higher prices lead to more drilling and more volume. That in turn leads to lower prices and, eventually, less drilling and less volume.
And so Kinder Morgan stock doesn’t look all that much different from that of energy producers. The stock plunged back in 2015 as the market correctly priced in a steep dividend cut. Investors who timed the bottom did well, but 2020’s industry problems have led KMI stock back to the lows.
At those lows, KMI at the least is intriguing. Management remains well-regarded. Its pipeline footprint is among the best in the country. Prices are low, but production needs to stay elevated, and should rise once demand normalizes as the coronavirus pandemic (hopefully) recedes.
With a dividend yield of roughly 8%, Kinder Morgan does not need to post explosive growth — or even any growth — to provide solid returns. Just avoiding the worst-case scenario should be enough.
Cabot Oil & Gas (COG)
Natural gas stocks have done better than other energy stocks — but they have not exactly done well. Cabot Oil & Gas, for instance, has seen its stock trade roughly flat over the past five years. Investors obviously could have done far better elsewhere in the market.
Looking forward, however, the case for natural gas names seems attractive. As I detailed in March, lower crude prices and production are a potential tailwind to natural gas prices. Shale producers were finding so much natural gas that some literally paid to have it taken away. Others simply burned — or “flared” — it on-site.
Natural gas too can benefit from the retirement of coal-fired power plants, which continues despite efforts from President Donald Trump. And, as with any commodity producer, COG stock provides leverage to the price of the underlying commodity.
In other words, higher natural gas prices should mean higher prices for COG stock. And there seems at least a reasonable chance of higher natural gas prices at some point.