The price of crude oil has been slammed over the past year as surging supplies have been meet with less robust demand than expected. This forced oil companies to take action to cut supplies by significantly reducing investments in new wells. It's expected that this should lead to declining oil production by the second half of this year, which would lead to a rally in the price of oil. Because energy stocks move with oil we could see a second half rally in energy stocks as that thesis plays out. Here are three energy stocks we think are worth buying to profit from the coming rally.
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Matt DiLallo: I'm a firm believer that the current oil price isn't high enough to keep oil production growing at an acceptable rate to meet future demand growth. The reason for this is that the current oil price doesn't provide enough cash flow or high enough returns to incentivize oil companies to fund the investments in new wells needed to keep oil supplies rising to meet the world's growing demand for oil. That's why I've been taking advantage of the downturn in the oil price to stock up on oil stocks. One that I'm seriously thinking about buying next is EOG Resources.I think it's simply the best U.S.-focused oil company and therefore primed to spring higher once oil prices begin to rally.
EOG Resources has a very bold plan to profit from a rebound in the oil price. After growing its oil production by a compound annual growth rate of 37% over the past three years the company is stomping on the brakes in 2015 and not growing its production at all. Instead, it's using its available cash flow to drill, but not complete, hundreds of wells. Its plan is to defer those completions until oil prices improve. The net result will be a substantial boost in returns once oil prices rebound as we see on the chart below.
Source: EOG Resources Investor Presentation.
What this suggests is that the company has two big catalysts on the horizon. Not only should its stock, which is 24% off its 52-week high, rebound along with oil prices, but its production will surge adding a second leg to the rebound. That's why I think investors should consider buying EOG Resources before the oil price begins its rebound later this year.
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Bob Ciura:Chevron Corporationis an energy stock on the cusp of a rebound, because its business is strong and its stock is cheap. Chevron's stock price has declined 22% from its 52-week high. Of course, this was due to the huge drop in oil prices over the past several months. But Chevron has fared better than many other energy companies throughout the oil crash. Its fundamentals are holding up extremely well, thanks to its integrated business model.
Chevron earned $19.2 billion last year in net profit. This was only a 10% year-over-year decline. All things considered, Chevron's results could have been far worse. Earnings were boosted by its large downstream business, which includes refining. Refining tends to improve during strong fluctuations in oil prices, since this volatility widens refining margins. Because of this, Chevron's downstream profits nearly doubled last year, to $4.3 billion. Growth in downstream profits greatly helped offset an 18% drop in profits from oil and gas exploration and production activities last year.
Chevron's fundamentals have held up, and yet, its stock price is declining. As a result, the valuation is now attractive. Chevron's stock is cheap, trading at just five times enterprise value-to-EBITDA. And, Chevron pays a hefty 4% dividend yield, which represents a multiyear high for this company. If oil can simply manage to find a floor this year, it's likely investors will return to Chevron, because of its strong business, cheap shares, and high dividend yield.
Dan Caplinger: Like many energy companies, LINN Energy has seen massive declines in its share price, with its most recent guidance suggesting major drops in capital spending in preparation for a possible extended period of low oil prices. Interestingly, LINN's related entity, LinnCo , has seen even steeper declines, and now trades at a sizable discount to LINN Energy units despite the fact that LinnCo's sole holdings are interests in LINN Energy.
Recently, LINN Energy and LinnCo announced a $1 billion partnership with a private capital investor to help finance acquisitions of oil and natural gas assets. With many such assets at distressed prices, investors hope that LinnCo and LINN Energy will capitalize on the many bargains available in the marketplace, setting the stage for an even more substantial bounce in their share prices when energy prices rebound. Although both entities should see their prices go up in that scenario, LinnCo arguably could see even greater gains if investors allow the current discount to narrow. Moreover, unlike LINN Energy, LinnCo is taxed as a regular corporation, avoiding some of the tax hassles that investors in MLPs and similar entities have to face. LinnCo certainly has further risk if energy prices stay low, but for those willing to take on that risk, the rewards could be sizable as well.
The article 3 Energy Stocks to Buy Before They Rebound originally appeared on Fool.com.
Bob Ciura owns shares of Linn Co, LLC. Dan Caplinger has no position in any stocks mentioned. Matt DiLallo owns shares of Linn Co, LLC and Linn Energy, LLC. The Motley Fool recommends Chevron. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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