With the market setting new highs and valuations at historically lofty levels, risk-averse advisors may look to market laggards, including opportunities in the energy sector. Several MoneyShow.com contributors review a dozen ideas among energy stocks, MLPs and ETFs.
Ian Wyatt, High Yield Wealth:
Schlumberger (SLB) is a niche giant; and size matters for income investors seeking safe dividends from energy investments. The oil services company is the biggest of its kind.
Operating in 85 countries, its equity market cap exceeds $88 billion. It is the leading provider of technology for drilling, production and processing to the oil and gas industry. The firm provides the know-how and hardware for onshore and offshore energy explorers.
The firm’s size has mattered to its investors. Roiling oil and gas prices have roiled the dividends of many energy companies over the past three years. Schlumberger’s dividend has held firm, like the other giants.
Schlumberger has more than held firm. Energy prices plunged in late 2014 and early 2015, but the company was able to raise its dividend 25% to $2 per share. The dividend, with its 3.2% yield, is at the high end of the market. Its size has enabled it to maintain its dividend.
Meanwhile, international deep-water drilling is particularly ripe for a rebound. Schlumberger generates 65% of its revenue outside of North America.
Schlumberger is the gold standard of the oilfield-services industry, not just because of the size and scale of its operations, but because it can generate earnings when energy prices are low. Its current share price fails to capture its true value. Investors are excessively pessimistic.
This is a big company with a big future. We value Schlumberger at $80 per share based on a 14 multiple of expected cash flow — EBITDA — of $8 billion in 2018. Our multiple is conservative. It’s below the historical 15 multiple that we think the stock deserves.
We see 25% upside potential over the next 12 months based on the firm’s reliable earnings and cash flow through all phases of the energy cycle.
Roger Conrad, Capitalist Times:
Kinder Morgan (KMI) — a holding in our Lifelong Income portfolio — announced third-quarter results, and held a conference call to update guidance.
Low investor expectations embodied in low valuations are a major advantage when the spotlight is on. Kinder Morgan has faced investor skepticism since last July.
The primary reason: There are worries that the proposed Trans Mountain pipeline expansion will be delayed or even derailed by opposition from British Columbia’s provincial government.
Management has pushed back its projected in-service date of the project to late 2019. That, however, didn’t prevent Kinder from topping guidance for distributable cash flow during the quarter. Kinder affirmed its full-year discounted cash flow guidance of $1.99 per share, and projects debt-to-earnings to end the year at a target 5.2-to-1 ratio.
The bottom line from the results is that it was another solid quarter for Kinder, further evidence the company has adapted to the lower for longer energy price environment.
For us, the numbers affirm new investment and resulting dividend growth as powerful long-term upside catalysts for the share price. Although gains are likely to be held back so long as Trans Mountain appears challenged, Kinder Morgan is a sound bargain in the U.S. midstream energy business.
Bill Selesky, Argus Research:
Based in Dallas, HollyFrontier Corp. (HFC) is an independent petroleum refiner and marketer that owns five refineries. The shares fell from January to June 2017, but have moved higher since that time amid rising commodity prices and declining crude oil inventories.
Our upgrade of the stock to Buy reflects our expectations for sustainable oil prices in the $50-$60 per barrel range over the next year, which we expect to further boost refining margins.
We also expect the company to benefit from diminishing inventories of crude oil, gasoline and diesel products. We note that the company posted significantly higher earnings in 3Q17, and are raising our EPS estimates for both this year and next.
The shares fell from January to June 2017, but have moved higher since that time amid rising commodity prices and declining crude oil inventories.
We are raising our 2017 EPS estimate to $2.19 from $1.32 to reflect the better-than-expected third-quarter results and our expectations for a continued recovery in refining margins. We are also raising our 2018 estimate to $2.65 from $2.10.
Our new target price of $53 assumes a multiple of 20.0-times our 2018 EPS estimate, and a potential total return, including the dividend, 24% from current levels.
Tony Daltorio, Investors Alley Premium Digest
Under the guise of clamping down on “widespread corruption,” Prince Mohammad bin Salman is sending a clear message to the Saudi elite that he is running the show. It isn’t a coincidence that these events propelled the price of oil to the highest level in two years.
If you are interested in broad exposure to the still beaten-down energy sector instead of a specific stock, here are my suggestions among ETFs:
For a more leveraged play on the price of oil, there is the Van Eck Vectors Oil Services ETF (OIH). Its portfolio contains most of the major oil service companies, with an emphasis on the two giants in the industry – Schlumberger and Halliburton (HAL). This ETF is still down more than 27% year-to-date and about 11% over the past year.
Another choice is the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). Its portfolio contains a wonderfully wide range of U.S. oil companies including most of the shale oil and gas companies. This fund is down 12.25% so far in 2017 and down only 2% over the last 12 months.
If your taste runs to the mega-cap oil companies, a good fund is the Vanguard Energy ETF (VDE) with the two largest positions being ExxonMobil (XOM) and Chevron (CVX). This ETF is down 8.75% year-to-date and 1.5% over the last 52 weeks.
All three ETFs should continue to do well as more turmoil is caused Prince Mohammad bin Salman’s continuing quest for power.
Marathon Petroleum (MPC) released third-quarter results that reflected strong performance among its three primary business units. The company reported earnings per share (EPS) of $1.77 compared to 27 cents during the same period last year.
Marathon’s refining operations were only mildly impacted by Hurricane Harvey’s direct hit on Houston, recording its best quarter in two years with $1.1 billion in sales. The firm’s chain of Speedway retail service stations duplicated its performance from last year, chipping in $209 million of revenue.
The company’s “midstream” collection of pipelines and storage facilities reported its best quarter ever, racking up $355 million in sales. A quarter like this reveals the wisdom of Marathon’s overall operating structure. Low oil prices increase profitability for its refining unit, while higher prices mean wider profit margins for its Speedway division.
Meanwhile, its midstream operations provide stable income that can be reinvested into new assets. I don’t expect to see MPC gain another 40% over the next 12 months, but it should hold up much better during the coming correction than overpriced momentum stocks. Marathon is a Buy up to $60.
Bob Carlson, Retirement Watch:
I think we’re finally seeing the bottom forming in MLPs, which is good news for JPMorgan Alerian MLP ETN (AMLP). We re-entered this investment a little early. It appeared the decline from the energy bear market was over, but there have been some residual effects in the last few months.
Over the summer, a major MLP surprised the market with reductions in its distributions. In October, the largest master limited partnership, Enterprise Products Partners (EPD), announced that over time it would use its own cash flow to expand, instead of relying on loans and other external capital.
The MLP market had a strong negative reaction to the news in October, erasing recent gains and falling to a new low for 2017. Now, it looks like the markets have adjusted.
MLPs should benefit from higher energy use and increased production in the United States. There still are risks from higher interest rates and the general skittishness of the individual investors. JPMorgan Alerian MLP now yields a little over 7%. And if there are no more surprises, we should see the fund recover into 2018.
Chuck Carlson, DRIP Investor:
Our Editor’s Portfolio has only one energy-related stock, ExxonMobil. The stock has rebounded with the group, as these shares are up roughly 6% since bottoming at the end of August.
I remain skeptical that oil prices can aggressively move past the $60 per barrel price. I expect higher prices will be a catalyst for more drilling and bring more supply to market, thus dampening prices.
The bottom line is that while the group’s performance is recovering, it feels too early to be overweighting energy stocks. If you want exposure to the group, I continue to recommend focusing on quality plays like ExxonMobil.
The stock doesn’t show the big gains that occur with more speculative players in the group, but ExxonMobil should hold up much better in more volatile environments. And the stock’s yield of 3.8% is reasonable payment while waiting for a more enduring rebound in the stock.
ExxonMobil offers an extremely friendly direct-purchase plan. Minimum initial investment is $250. There is no enrollment fee and no fee to purchase shares in the plan.
Elliott Gue, Energy & Income Advisor:
In its second-quarter earnings call, management at Occidental Petroleum (OXY) reiterated its commitment to maintaining (near-term) and growing (intermediate-term) the dividend.
This goal will require the company — a holding in our Wealth Builders model portfolio — to grow cash flow to levels that support the current payout and fund the capital expenditures needed to hold production flat at $40 per barrel.
Management also made the case for Occidental Petroleum to cover its payout and grow production by 5 percent to 8 percent annually if oil prices hover around $50 per barrel.
In the near term, Occidental Petroleum must focus on replacing last cash flow from divested assets via production growth in the Permian Basin, the start-up of projects in its petrochemical segment and the expansion of the Al Hosn gas project in the United Arab Emirates.
Occidental Petroleum boasts an impressive footprint throughout the Permian Basin, as well as substantial acreage position in the region that hasn’t been evaluated, creating the potential for additional inventory upside as other operators delineate nearby assets.
The company continues to run rigs in the Texas portion of the Delaware Basin and the Midland Basin. Its economics in the Delaware Basin should continue to improve from the build-out of logistics hubs.
Growth-oriented investors argue that Occidental Petroleum’s generous dividend would be better deployed in additional drilling and completion activity; income-oriented investors remain skeptical about the payout’s sustainability and growth potential.
Despite this tension, Occidental Petroleum exhibits many of the qualities we prize in an exploration and production company: a strong balance sheet (a leverage ratio of 2.39 times and $2.2 billion in cash), franchise assets in the Permian Basin and steady cash flow from conventional fields. Occidental Petroleum Corp rates a Buy up to $70.
Bob Ciura, Daily Profit:
The offshore drillers have sat drydocked for the past three years. The all-time high values of a decade ago have given way to all-time low values today.
Rare is the analyst with the name of an offshore driller atop his recommendation list. Bully for us, because the offshore drillers are rising to the top of my recommendation list
None has risen further than Diamond Offshore Drilling (DO), a leading offshore driller. Diamond has endured the down-cycles before. And it has not only endured but prospered. Diamond is majority owned by Loews Corp. (L), which is run by the Tisch family. The Tisches are skilled value managers capable of exploiting opportunities.
Diamond shares had traded at a mere one-third of book value as recently as August. The shares have rallied 55% over the past two months. Yet despite the recent gains, the shares still trade at half of book value. They still trade at an 80% discount to the five-year high of $75.
Energy investments have rarely been so cheap over the past 30 years. Diamond has never been this cheap. That’s a fact worth pondering. The last time Diamond was close to being this cheap, in 1995, investors were able to turn every $1,000 investment into a $10,000 within a decade.
Bryan Perry, Cash Machine:
MPLX LP (MPLX) remains my top energy holding. The MLP posted strong Q3 results with net income rising 43% year over year to $538.0 million.
Third-quarter earnings before interest, taxes, depreciation and amortization (EBITDA) were 14.0% higher than Q2 2017, a sign of excellent sequential growth.
The company also raised its quarterly distribution by 4.0% to $0.5625 per share, making it the 19th increase since its initial public offering back in 2012.
Meanwhile, its parent mothership, Marathon Petroleum Corp., announced an agreement for the dropdown of refining logistics assets and fuels distribution services to MPLX for total consideration of approximately $8.1 billion.
The transaction is expected to close on February 1, 2018, and be immediately accretive to MPLX’s distributable cash flow per unit. These assets and services are projected to generate annual EBITDA of $1 billion.
Marathon Petroleum is contributing these assets and services in exchange for $4.1 billion in cash and MPLX equity valued at approximately $4 billion. We consider this to be great news and recommend that investors maintain their long positions.