It’s no secret that the rout in oil and natural gas prices has taken many energy stocks to the woodshed. Declines of 15%, 30%, even 50% are commonplace across the sector.
And while some have rebounded slightly on the prospects of higher oil, the vast bulk of the sector still sits closer to 52-week lows than highs. That makes the oil and gas sector a prime place to find bargain stocks.
But how do you know, you’re actually getting a bargain and not just a firm who’s dropped by a bunch? The trick to finding bargain energy stocks is focus on “GARP.”
GARP (growth at a reasonable price) investing tries to blend the attributes of both growth and value stocks into one thesis. GARP practitioners look for firms that show consistent earnings growth above market levels while excluding stocks with high valuations. Followers of GARP often will point to a particular metric in their quest to find stocks — the humble price/earnings-to-growth ratio.
PEG is fairly simple — a PEG of 1 is considered fairly valued, above 1 is overvalued, and under 1 is undervalued.
Based on that metric, there are at least five energy stocks that fit the bill as bargain buys:
Bargain Energy Stocks: Diamondback Energy (FANG)
PEG Ratio: 0.74
The key to surviving in this time of lower oil prices is to find the areas of shale that are economically viable at these lower prices.
The Permian Basin is one of them, and Diamondback Energy (FANG) is just killing it in the region.
Diamondback is a smaller producer that owns roughly 89,000 acres in the Midland Basin of the Permian. The key for that acreage is that its sits atop several strata of different shale formations — the Lower Spraberry, Wolfcamp, and Cline shales. That means FANG can hit multiple formations from a single well pad.
That’s huge when it comes to keeping costs low while still being able to produce. FANG has some of the best margins in the business.
Additionally, low debt levels, accretive acquisitions and abundant liquidity — thanks to cash on hand, growing cash flows and access to its funding vehicle, Viper Energy Partners LP (VNOM) — have FANG poised to not only survive this oil slump, but thrive in it.
But the market seems to be ignoring its potential. FANG can be had for a PEG of just 0.74 on earnings that are expected to grow 60% annually over the next five years!
Bargain Energy Stocks: HollyFrontier Corporation (HFC)
PEG Ratio: 0.69
Not all the energy stocks that are growing like weeds are doing so on the production side of things. Refiner HollyFrontier (HFC) is a prime example.
HFC — like most energy stocks — was taken down hard between last summer and January of this year as oil prices plummeted. While it has recovered, shares still are well off their 2014 highs. And shares look even more like a bargain when you consider that it actually thrives on lower oil prices.
HollyFrontier is a refiner of petroleum, which means it takes raw crude oil and processes it into gasoline, jet fuel and other products. It wants crude oil as low as possible, so it can make as much money on the price difference between the two. Margins are fat at HFC, and they are getting fatter. The refiner basically refines cash flows in this sort of oil price environment.
Earnings estimates continue to climb for HollyFrontier as crude has stayed low throughout the second quarter. All in all, full-year earnings estimates for HFC have risen by an average of 5.4% since June. This will build on HollyFrontier’s first-quarter earnings beat and momentum.
Add in a 3% dividend yield and earnings that are expected to grow more than 16% over the next five years, and it’s hard not to love HFC right now.
Bargain Energy Stocks: Dril-Quip (DRQ)
PEG Ratio: 0.88
As oil has fallen, so has drilling activity — not a great trend if you supply drill bits and other rig equipment. So it’s easy to see why Dril-Quip (DRQ) has fallen about 37% over the past 52 weeks.
Of course, punish a share long enough, and it starts to look like a value.
And if you consider Dril-Quip’s growth potential, DRQ really starts to look like a value.
The key for Dril-Quip is its backlog. DRQ is a leading manufacturer of highly engineered offshore drilling and production equipment — the kind that is suited for use in deepwater and harsh environment applications. The bulk of its $1.2 billion backlog is multiyear projects in the Gulf of Mexico and Brazil. These sorts of projects aren’t getting axed as drilling has already commenced on many of them. What’s more is that DRQ’s margins on its products — since they are specialized — are pretty juicy.
That’s great for Dril-Quip’s bottom line, and part of what helps DRQ run debt-free.
With a PEG just below 0.9 and double-digit long-term earnings growth prospects, DRQ stock won’t stay cheap for long. And it also has been pegged by at least one market research firm as a potential buyout candidate.
Bargain Energy Stocks: California Resources (CRC)
PEG Ratio: 0.08
Occidental had been a producer in California for decades. The problem was the conventional oil and gas wells in the state — along with its higher regulatory environment — were holding OXY back from its higher-growth areas. So after some activist pressure, OXY let loose of CRC.
That spinoff happened at just the wrong time. CRC sank like a stone, and while it recovered once, it is on the decline again, off 45% in the past three months.
Let other investors’ pain be your gain. California has abundant energy, and CRC has the largest acreage position in the state — approximately 2.4 million acres. You get coverage over the state’s four major basins, 19,800 drilling locations and 6,400 prospective new drilling sites for a song. Plus, California Resources has a large midstream portfolio that it can monetize.
While CRC is running in the red currently, it’s expected to flip to quarterly profits midway through next year. Among the bargain energy stocks mentioned above, this might be the deepest value.
Bargain Energy Stocks: Hess (HES)
PEG Ratio: 0.78
Sometimes activism can be good. In the case of energy producer Hess (HES), it has been really good.
A few years ago, hedge fund Elliott Management got involved in Hess’ story and pushed hard for the firm to lose its integrated ways. That meant transitioning from an integrated energy stock to a predominantly E&P only entity.
Asset sales followed — including fields in Asia, its energy-marketing/trading business, various midstream pipelines and acreage in the Bakken and Utica shales. The asset sales included its iconic green and white service stations.
However, the Hess truck is far from dead.
HES has plowed the funds from those sales into its E&P budgets and has been focusing on low-risk unconventional sites rather its high-impact exploration. That means HES can spend less on capex but still churn out steady and rising production. Production at the firm should rise by 5% to 8% over the next three years. That’ll help Hess churn out plenty of cash as well.
Hess shares have dropped like a rock since the oil rout started, off some 35% in the past year, so on a price level, it certainly looks like a bargain. The five-year PEG of 0.78 also indicates it’s undervalued. But it is worth noting that HES is projected to post a deep loss this year, and while 2016 will be better, more red ink is expected. This is a longer-term recovery project — but it doesn’t mean the market won’t warm to Hess all the same.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.