The valuations of energy stocks have declined at one of their fastest clips this year thanks to a stubborn supply overhang, a price war, and massive demand destruction due to the Covid-19 crisis. Whereas oil prices have staged a nice rebound from their historical lows after OPEC+ supply cuts and a gradual reopening of economies across the globe, a painfully slow recovery coupled with a resurgence of Covid-19 cases has dulled near-term prospects for energy demand, capped oil prices and left many energy stocks still selling at massive discounts to their pre-crisis levels.
This appears to be a perfect backdrop for bottom-fishing opportunities--but only for investors who can withstand the attendant volatility.
Whereas companies that operate essential assets in the sector could provide good opportunities for value investors, there is a high likelihood that many seemingly cheap stocks will become value traps given the seismic changes the sector has gone through during the past few months.
The shale sector appears particularly risky, with the pioneer of fracking Chesapeake Energy (NYSE: CHK), finally filing for bankruptcy and dozens of small shale players expected to follow suit. Investors are advised to keep a close eye on the $40/barrel level with Deloitte revealing that about a third of U.S. shale producers are technically insolvent at $35/barrel.
And now the brass tacks. Here are three oil and gas plays to consider for your portfolio and 3 to avoid.
Looking like buys:
#1 Chevron Corp.
Oil supermajor Chevron Corp. (NYSE: CVX) is once again in the limelight--this time for the wrong reason--after the District of Columbia attorney general filed a lawsuit against the company and its peers ExxonMobil (NYSE: XOM), BP Plc. (NYSE: BP) and Royal Dutch Shell (NYSE: RDS.A) for "systematically and intentionally misleading" consumers about their role in climate change.
You can be sure that this won't be the last you will be hearing of this subject.
Nevertheless, CVX remains a top sector pick thanks to a strong balance sheet, low debt (Debt to Equity of 22% compared to 47% for the energy sector), sizable dividend 5.89% (fwd yield) which looks sustainable after the company lowered capex from its initial projections of $20 billion for the current year to $14 billion and operating expenditure by another $1 billion.
A recent analysis by WoodMackenzie found that Chevron and Shell are the most resilient among the oil majors due to their higher exposure to high-margin assets that can withstand low energy prices. Although CVX stock might not have a lot of upside at this point due to its premium valuation, it still offers better defensive qualities than most in the sector.
#2 Williams Companies
Williams Companies Inc. (NYSE: WMB) is an operator of pipelines and other midstream assets with a focus in the Northeast, where it serves Marcellus Basin natural gas producers.
With natural gas prices recently dropping to 25-year lows, many investors wouldn't touch the sector with a 10-foot pole. Nevertheless, WMB is one of the leaders in the midstream space with minimal exposure to commodity prices since it generates nearly all of its cash flows from fee-based sources. Related: Oil Rallies On Bullish EIA Inventory Data
Most of the company's customers appear to be in little danger of going bankrupt, with the firm having lowered its exposure to embattled Chesapeake to 6% from 18% a couple of years ago. Further, management has expressed confidence in its ability to defend the integrity of the company's contracts.
Williams has continued to exhibit relatively strong performance during these trouble times, reporting a 4% Y/Y growth in adjusted EBITDA to $1.26 billion and a 10% increase in discounted cash flow to $861 million despite incurring a net loss of $518 million.
With a dividend yield (fwd) of 8.71% and a low short interest of 1.60%, WMB is one of the safer midstream energy plays.
#3 NuStar Energy
San Antonio-based NuStar Energy (NYSE: NS) is a master limited partnership (MLP) that owns and operates 10,000 miles of pipeline and 75 terminal and storage facilities for the storage and distribution of crude oil, specialty liquids, and refined products. The stock offers a high distribution yield (fwd) of 11.89% and a moderate short interest of 4.13%.
Energy MLPs are usually less exposed to oil and gas prices than mainstream E&P players and continue collecting royalties even when the E&P companies that own them go bankrupt.
Nevertheless, they are not completely immune, and NuStar Energy recently cut its distributions by a third. Thankfully, the company is only moderately leveraged, which, coupled with the huge 67% capex cut, lowers the risk of further big cuts.
The ones to avoid:
#1 Occidental Petroleum
Occidental Petroleum (NYSE: OXY) has become the poster-child of an M&A deal gone bad after its $55B acquisition of Anadarko left it saddled with a massive $38.5 billion debt pile.
On the surface, OXY looks like a good turnaround bet after nearly doubling from its March 23 lows. Short interest has also gradually been declining to the current 5.90%. But that's before you consider that the company has a very long road back to the top. First off, the company's efforts to sell assets worth $8.8B in Algeria and Ghana in a bid to cut its debt obligations have come up short. Now OXY plans to take $6B-$9B in impairment charges for its oil and gas assets.
OXY is left with little choice but to lap up more debt in a bid to stay afloat--which it is doing at a high cost.
Bloomberg has reported that OXY has just snagged $3B in its first every junk bond sale. The pricing of the unsecured offering includes a 5-year bond @ 7.75%-8% yield, a 7-year note @ 8.25%-8.5%, and a 10-year security @ 8.75%-8.875%. Ironically, plans to use $1.5B of proceeds from the sale to buy back bonds maturing in 2021 and 2022. Consequently, Moody's has downgraded the company credit rating a notch to Ba2.
OXY might be succeeding in buying itself more time, but this might soon prove to be a vicious cycle if low energy prices persist, forcing the company to take more asset writedowns and make more trips to the debt market at ever-rising costs.
#2 Denbury Resources
Denbury Resources (NYSE: DNR) is a Texas-based company engaged in hydrocarbon exploration. As a $167.2M (market cap) shale producer, it might not attract the same attention as heavyweights like OXY. However, it's many of these smaller shale producers that carry the highest risk of going under. DNR's management has just elected to skip $8M interest payment due June 30 on senior notes due 2024 to "evaluate strategic alternatives."
During the company's last earnings call, Denbury's management had warned:
"There can be no assurances that the company will be able to successfully restructure its indebtedness, improve its financial position, or complete any strategic transaction."
That's a dead ringer for a company staring bankruptcy in the eyes. Related: Saudi Arabia Eyes Total Dominance In Oil And Gas
Denbury's business is unique because it involves injecting CO2 into older reservoirs to squeeze the remaining resources out. Whereas this model has its attractions, chief among them being nearly non-existent exploratory expenses, extraction costs can be rather high--Denbury's per-barrel expenses last term clocked in at $46.31.
That, coupled with the latest development, makes this a very high-risk stock to own, and it is off 15.7% on the day.
#3 Marathon Oil
Oil prices have gained 20% over the past 30 days and helped lift the energy sector as a whole. Unfortunately, refineries like Marathon Oil (NYSE: MRO) and Valero Energy (NYSE: VAL) are still struggling to gain traction, with the country's refinery in use at tracked at 74.6% at the end of last week compared with more than 90% that is usually the norm at this time of the year. Meanwhile, crack spreads remain painfully squeezed and well below their trailing 12-month averages.
On its part, Marathon oil is actually a good mid-term bet due to its relatively strong balance sheet, including an untapped credit facility of $3 billion.
Unfortunately, the company continues facing daunting near-term prospects considering that it had hedged its oil prices for the June quarter at $30.33, or nearly $10/barrel below current prices. Further, sentiment on the company has been worsening with Moody's lowering its bonds to "junk" status in May.
By Alex Kimani for Oilprice.com
More Top Reads From Oilprice.com:
- Supermajors Are Flocking To This Booming Oil Frontier
- Big Oil’s Nightmare Is Coming True
- Turning California’s Biggest Liability Into A Biofuel Boom