Last year was an odd one for the energy sector. Oil prices rebounded sharply in the second half, with WTI crude rising by about 11% to end 2017 at more than $60 a barrel, a two-and-a-half year high. That might have been expected to fuel big gains for energy stocks. Instead, most of them lost value last year.
Because of that, 2018 could be a bounce-back year for the sector, especially if crude oil prices continue heading higher. That said, even if they don't, these three energy stocks could still enjoy big years. Here's why.
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The recipe for a rebound
Natural gas pipeline giant Kinder Morgan (NYSE: KMI) declined 13% last year even though it completed its turnaround plan, and distributable cash flow (DCF) -- the excess cash it can use to pay dividends -- held roughly steady. Shares currently trade at a rock-bottom price of 8.8 times 2018 DCF, which is well below the average 14.9 times DCF multiple of its peer group.
That discount could narrow in 2018 thanks to several catalysts. First, Kinder Morgan expects to boost its dividend 60% this year, which would push its yield up to 4.4%, making it more attractive to income investors. In addition, it plans to repurchase up to $500 million of its stock, which could also help drive the price higher. Finally, the company could begin construction on its controversial Trans Mountain Pipeline expansion in Canada. Investors had worried that local opposition might stymie the project. However, the company recently won a crucial court battle, which increases the odds that it will be able start construction this year. If that happens, it will lift a huge weight of uncertainty that has been holding down Kinder Morgan's valuation, since Trans Mountain represents a substantial portion of the company's growth prospects.
High return growth plus cash returns
Oil giant Anadarko Petroleum (NYSE: APC) tumbled 23.5% last year -- one of the worst performances among big oil stocks -- despite making excellent progress on its plan to adjust its business so it can thrive at lower oil prices. For example, the company has increased its margin per barrel by 34% while significantly improving its balance sheet. These moves put Anadarko in position for a strong year in 2018.
In fact, at $50 a barrel oil, the company says it would generate enough cash flow to fuel $4.2 billion to $4.6 billion in capital investments, which in turn would allow it to increase its oil output by 14% versus 2017. Given that crude is currently well over $50 a barrel, Anadarko is on pace to generate significant free cash flow; it noted in late November that it could produce more than $700 million in free cash this year based on where prices were at the time. That would give the company even more money to return to investors on top of the $2.5 billion share buyback program it announced in September. That sizable buyback, when combined with its growing free cash, could fuel a rebound in the company's stock price this year.
A new parent with a plan to create value
Shares of renewable energy generator TerraForm Power (NASDAQ: TERP) slumped 7.7% last year. On the one hand, that decline wasn't that surprising since cash available for distribution (CAFD) -- money the company could pay out to investors via dividends -- fell 37.5% through the third quarter. One of the issues was weaker than expected power production. For example, in Q3, the electricity generated from the company's wind farms came in 13% below the previous year due to a wind resource that was 20% below average.
That said, 2017 was a transformational year for the company because it changed its parent company, replacing the bankrupt SunEdison with leading alternative asset manager Brookfield Asset Management (NYSE: BAM), which took a 51% stake in TerraForm. Brookfield has already instituted several changes that should enable TerraForm Power to start distributing cash to investors in 2018. In fact, the company plans to return 80% to 85% of its CAFD to investors each year, and believes it can grow its payout by 5% to 8% annually. The company's return to growth mode and the revival of its dividend should combine to fuel a double-digit percentage total return for investors in the coming year.
Looking forward to the catalysts
Each of these three energy stocks had a down year in 2017, even though each took giant leaps toward improving their ability to grow in the current environment. Because of that, all could bounce back sharply in 2018, especially as the various expected catalysts arrive. It's those catalyst-driven upsides that make them good stocks to consider buying this year.
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Matthew DiLallo owns shares of Brookfield Asset Management and Kinder Morgan and has the following options: long January 2018 $30 calls on Kinder Morgan and short March 2018 $17 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.