The 3 Best-Kept Secret Stocks of the Oil & Gas Sector

By Matthew DiLallo, Tyler Crowe, and Jason Hall Markets Fool.com

We're going to let you in on a little secret. Some of the best investment ideas are often hiding in plain sight. That's because investors tend to focus on the stocks everyone else is talking about, often overlooking great companies right next door. That certainly seems to be the case withHolly Energy Partners (NYSE: HEP), Core Labs (NYSE: CLB), and Concho Resources (NYSE: CXO), which we think are some of the best-kept secrets in the energy sector.

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All the qualities you want in an energy dividend

Tyler Crowe(Holly Energy Partners):When it comes to dividend investing, there are three things you want: high yield, long-term sustainability, and growth. Unfortunately, you normally have to only pick just two of those traits at the same time, because getting all three at the same time is a real rarity. However, one company that does rather well on checking all three of these boxes is Holly Energy Partners. Since the companywent public in 2004, it has grown its payout every quarter at an annualized rate of 8.5%. Today, Holly Energy Partners stock yields 6.8%.

Image source: Getty Images.

So, the growth and high yield part of the equation look attractive. What sets this company apart from its peers that also shoot for high yield and growth is that Holly Energy Partners' payout looks relatively sustainable over time. The companyis able to achieve payout sustainability through two key factors: a conservative approach to both its operations and capital allocation.

Most master limited partnerships in the oil and refined product transportation business leave a small portion of their revenue exposed to capture some modest benefits when prices are strong. Holly Energy Partners eschews this approach and elects instead to sign contracts where 100% of its revenue comes from fixed fees and commitments for minimum service. In doing so, it ensures a much more consistent revenue and cash flow stream that make planning its payout much more predictable over time.

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Similarly, Holly Energy Partner's management takes a slow but steady approach to capital allocation. Rather than trying to make big splash acquisitions or boast a huge backlog of projects, the company makes modest additions to its portfolio while maintaining an investment grade credit rating and not having to issue lots of equity to pay for projects. By keeping share counts more consistent, those per-share distribution increases are more achievable over time.

HEP Average Diluted Shares Outstanding (Quarterly) data by YCharts.

Holly Energy Partners doesn't get much attention because it is a $2 billion midstream company in an industry that rewards size and scale, but the companyhas carved out a niche that has shown to be very rewarding for shareholders over the long term.

An invaluable service (and an ideal business model) keep this small company profitable

Jason Hall(Core Laboratories N.V.): As many investors have learned very painfully over the past several years, the energy industry's cyclicality can shift companies from big profits to even bigger losses very quickly. This is a product of an asset-heavy industry, with big, fixed expenses that can take a lot of time to bring down.

This is what makes Core Laboratories a little bit different. Core Lab is the rare "asset-light" company in the energy business, and it doesn't make a living drilling holes, operating expensive machinery, distributing equipment, or otherwise doing the heavy lifting that moves energy from the field to the consumer. Instead, Core Lab's business is all about analysis of oilfield data and providing producers with information that leads to cheaper, more complete oil and gas recovery.

The combination of Core's value to producers and its low-cost business model has kept the company profitable even as revenue has fallen:

CLB Revenue (TTM) data by YCharts.

And with the worst of the downturn looking like it's over -- Core Lab reported sequential revenue growth the past two quarters -- there's a very good chance Core will see its profits grow substantially, and potentially very quickly, from here.

The $20 billion oil stock no one talks about

Matt DiLallo (Concho Resources): The Permian Basin in western Texas is arguably the hottest oil play in the world right now. Thanks to its resource-rich rocks and low drilling costs, producers in the Basin can earn excellent returns in the current low oil price environment. Because of that, investors are pouring money into companies operating in the region. However, one stock investors seem to be overlooking is Concho Resources, which is a surprise given that this $20 billion oil stock is the largest pure-play on the Permian Basin.

Not only is Concho a large company in a red-hot oil play, but it'san excellent operator. It currently has the second lowest leverage ratio in its peer group, at just 1.2 times net debt-to-EBIDAX, well below the 2.4 times peer average. Meanwhile, it has delivered peer-leading compound annual average production growth over the past decade of 23% on a per-share basis versus just 6% on average from its peer group.

That said, Concho Resources' best days still lie ahead. Through a series of strategic acquisitions, it quietly built up a 600,000 net acre position in the Basin, which is one of the largest in the industry. Further, the company estimates that its position contains 8 billion barrels of net resource potential and 19,000 future drilling locations, which is also among the leaders. Those resources should fuel robust growth for years to come, with Concho anticipating that it can deliver 20% compound production growth through 2019 while living within cash flow at current oil prices. That's healthy growth for a company of its size.

However, for whatever reason, investors don't pay that much attention to Concho Resources despite the fact that it's an exceptionally run oil company with big-time growth potential. In my opinion, that powerful combination makes it one of the best-kept secrets in the oil patch.

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Jason Hall owns shares of Core Laboratories. Matt DiLallo owns shares of Core Laboratories. Tyler Crowe owns shares of Core Laboratories. The Motley Fool owns shares of and recommends Core Laboratories. The Motley Fool has a disclosure policy.