It’s still ugly in the oil patch. The price of crude oil seems to have stabilized at around $30 per barrel, yet bankruptcies still loom and dividend cuts continue to cast a long shadow over the energy sector. Oil stocks are in a nasty bear market with no apparent end in sight.
But when it comes to value investing, you could say it is darkest just before light.
The best value opportunities come when the situation looks to be so bad it can never get better … and then it does. Stock prices reach that point in which they discount the absolute worst-case scenario. And when reality proves to be even slightly less bad than feared, patient value investors walk away with outsized gains.
That’s where we are in the energy sector today. I’m still a little wary of exploration and development companies, and you won’t see me recommending Chesapeake Energy Corporation (CHK) just yet. But there are plenty of quality stocks to buy among the integrated majors and midstream operators.
In no particular order, here are 10 battered oil stocks to consider buying now.
Oil Stocks to Buy Now: Kinder Morgan Inc (KMI)
I’ll start with one that has recently gotten the attention of Warren Buffett — or at least of his holding company, Berkshire Hathaway Inc. (BRK.A, BRK.B).
I’m talking, of course, about midstream pipeline operator Kinder Morgan (KMI).
The entire midstream pipeline sector has taken a beating over the past several months, and Kinder Morgan bears a fair bit of responsibility for that. KMI has been considered one of the blue chips of the sector for years, and its dividend has always been considered sacrosanct. That is, right up until they had to cut it.
Kinder Morgan found itself in a pickle. It wanted to grow, but issuing bonds to fund that growth would have put its credit rating at risk. And issuing stock at the depressed prices of late last year would have unfairly punished its stockholders. So KMI did what it had to do and slashed its dividend to fund its growth projects.
Investors hated it, but it was a sensible call. And today, even post-cut, Kinder Morgan yields a not-too-shabby 2.8%.
Oil Stocks to Buy Now: Energy Transfer Equity LP (ETE)
Another problem child in the midstream energy space is Kinder Morgan rival Energy Transfer Equity (ETE). In February, Energy Transfer Equity rallied from a low of just $4 to over $7. That’s a 75% move in less than a month, which should look absolutely fantastic.
The problem is that ETE was a $35 stock as recently as June of last year. So ETE would need to rise by a factor of five just to get back to break even.
Energy Transfer is under major pressure because its planned merger with Williams Companies Inc (WMB) is looking to be more of a curse than a blessing these days. Williams has high exposure to Chesapeake Energy, which may very well go bankrupt before all is said and done.
Yet investors who shun ETE are missing the big picture. ETE is the top of the totem pole of an impressive collection of MLPs. ETE collects incentive distribution rights from Energy Transfer Partners LP (ETP), Sunoco LP (SUN) and Sunoco Logistics Partners L.P. (SXL). So whether the Williams deal comes to fruition or completely falls apart, the ETE empire looks stronger than ever.
ETE may very well have to cut its distribution to finance the merger with Williams. But as of now, the stock yields an impressive 16.4%.
Oil Stocks to Buy Now: Teekay Corporation (TK)
Maritime midstream operator Teekay (TK) is the proverbial baby that was thrown out with the bathwater.
There is a lot happening with this stock that is extremely good news for the next decade and beyond. But because of a short-term snafu with the credit market, investors have dumped TK and pushed its share price to absurdly low levels.
TK is transitioning itself from an operating business into a pure general partner. In MLP land, this means incentive distribution rights — and rapid distribution growth. But it also means a more streamlined and less asset-heavy business. You’re buying a management company rather than an operating business.
It was all going so smoothly. TK raised its distribution by 74% in June … only to turn around and cut it by 90% in December.
So … what happened?
In a word, debt. Given the turbulence in the junk bond market right now, TK feared that one of its underlying MLPs would have a hard time rolling over a maturing bond at a reasonable rate. So rather than take chances, they preemptively cut the distribution. Lower distributions at the daughter company level meant less cash at the parent company level… so TK had to slash its dividend.
Well, guess what: I’m not too worried about it. TK’s business has never been healthier, and I fully expect TK to start raising its dividend again within the next year or two. And at current prices, it yields a respectable 2.8%.
Oil Stocks to Buy Now: Enterprise Products Partners L.P. (EPD)
I’ve listed all of the “problem children” in the midstream pipeline space. Now it’s time to mention a model citizen: Enterprise Products Partners (EPD).
Enterprise takes the slow-and-steady approach to growing its pipeline empire. While some of its biggest rivals have gotten themselves in trouble by borrowing heavily to finance growth (ahem, Kinder Morgan), EPD has run a much more conservative business and has always paid out a lower proportion of its distributable earnings to its unitholders.
So, not only has EPD managed to avoid cutting its distributions … it’s actually had the flexibility to raise it. EPD hiked its distribution by a little more than 5% in January.
Yet despite Enterprise Products’ successful navigation of this difficult period for energy, its stock price has still gotten hammered. EPD’s share price is down by a third from its 52-week high and yields a ridiculous 6.8%.
From what I can see, EPD simply got dragged down with the rest of its peers as investors dumped everything even tangentially related to energy. I also suspect that leveraged MLP investors like hedge funds and closed-end funds were forced to sell EPD to meet fund liquidations, though this is harder to prove.
Frankly, it doesn’t matter why EPD’s share price collapsed. We can use the swoon as an opportunity to accumulate shares of one of the finest energy stocks in the world at a bargain-basement price.
Oil Stocks to Buy Now: Plains All American Pipeline, L.P. (PAA)
Rival MLP Plains All American (PAA) isn’t quite the blue chip that Enterprise Products is. Plains has had some growth issues of late, and its distribution was widely expected to be cut. At one point earlier this year, Plains was down more than 70% from its 52-week high. Even after a decent rally, shares are down about 60%.
That’s not pretty. But there are several reasons to believe the worst is behind this battered MLP.
To start, Plains tapped the private equity market for capital in January. This means Plains should be able to meet its growth plans and continue paying its distribution throughout 2016 and 2017 without having to access the public debt or equity markets.
But that’s not where the good news stops. Perhaps wanting to demonstrate a visible commitment to the company, several company insiders have been aggressively buying Plains All American shares on the open market. In February, Chairman and CEO Greg Armstrong dropped about $3.3 million on PAA shares, and another director picked up about $150,000.
At current prices, PAA yields an attractive 13%.
Oil Stocks to Buy Now: Blueknight Energy Partners L.P. (BKEP)
I’ll mention one last MLP before moving on to the oil majors: small-cap Blueknight Energy Partners (BKEP).
Like most MLPs these days, Blueknight has taken its share of lumps of late. Shares are down about 40% from their 52-week highs. But most of this damage is due to having the misfortune of being located in the midstream MLP sector. It’s guilt by association, and the entire sector has gotten slammed. Making things harder for Blueknight, its smaller market cap makes it naturally more volatile.
Yet there is a lot to like about Blueknight. To start, despite its small size, it runs a diversified mix of midstream businesses. In addition to crude oil transportation, storage and gathering, it also stores and terminals liquid asphalt and residual fuel oil.
For all of the volatility in the stock price, the underlying businesses appear to be performing exactly as expected. Blueknight raised its distribution by over 6% in January, and the payout is more than adequately covered. The coverage ratio is a solid 1.3 times.
At current prices, Blueknight yields an attractive 11.8%.
Oil Stocks to Buy Now: Statoil ASA (ADR) (STO)
Let’s now take a look at some beaten-down oil majors. American oil stocks have taken a pounding to be sure, but many European oil stocks have been hit even harder. In addition to having the same oversupply issues as their American counterparts, the European oil stocks have the additional misfortune of being domiciled in Europe, where valuations are lower and perceived macro risk higher.
One that I like particularly well right now is Norway-based Statoil (STO). Statoil has a handful of factors that make it somewhat unique among the global oil majors.
To start, while most formerly state-owned oil companies in the developed world have been privatized, Statoil can still count the Norwegian government as its largest shareholder. In fact, Norway owns fully two-thirds of Statoil’s stock.
Normally, I wouldn’t particularly like that, as I question the profit motivations of a company so deeply in bed with government. But considering we’re in the midst of a global oil crisis, I consider it a stabilizing factor. I don’t see Statoil coming under serious financial stress so long as the government is a major shareholder.
At current prices, Statoil yields an impressive 6.2%, which should be safe for now. Statoil recently introduced an option to allow investors to choose a scrip dividend (or a stock dividend) over a cash dividend. While this may somewhat dilute existing shareholders, it also conserves cash and keep Statoil’s balance sheet stable.
Furthermore, Statoil has been aggressively cutting costs and reducing capital expenditures to focus on only the most profitable projects. Statoil will emerge from this crisis lean and mean, and investors that held on during the dark times should be handsomely rewarded.
Oil Stocks to Buy Now: BP plc (ADR) (BP)
Poor BP (BP). As soon as the beaten-down oil stock started to recover from its 2010 oil spill disaster, it gets slammed by the biggest supply glut to hit in industry in decades. The timing couldn’t have been worse.
Yet things for BP aren’t quite as bad as they might seem.
To start, BP runs one of the leanest operations of the oil majors. BP trimmed the fat years ago as it sought to get its house in order after the Gulf of Mexico oil spill. It also slashed its dividend to conserve cash in 2010, and reinstating it at a much lower level in 2011.
Today, BP yields 8.1%, making it one of the highest-yielding large-cap stocks in the world. This raises the obvious questions of whether that payout is sustainable. Management has made maintaining the dividend an absolute priority and has been willing to slash its capex budget to make that happen. Management has also indicated that it has the capacity to increase its leverage if need be. Whether that is a wise decision is a different question altogether, but I would say that BP’s dividend looks safe for at least the next one to two years.
Given the paucity of cheap stocks these days, BP is worth the gamble. At current prices, a dividend cut is already priced in. And if crude oil prices manage to stabilize in the $40s or $50s, BP should enjoy a nice run.
Oil Stocks to Buy Now: Repsol SA (ADR) (REPYY)
Spanish oil major Repsol (REPYY) would seem to have several strikes against it.
To start, it’s an oil company … with a major presence in the shaky economies of Latin America.
And it’s domiciled in Spain … at the center of Europe’s ongoing monetary crisis.
Adding to Repsol’s woes, its board of directors opted to cut its dividend in February … the first time since 2009.
Perhaps not surprisingly, Repsol’s shares are down about 50% from their 52-week highs. But there are plenty of reasons to believe the worst is behind this stock. To start, its home market — Spain — is one of the cheapest stock markets in the developed world right now. I expect European stocks — and Spanish stocks in particular — to attract value investors this year. Secondly, the damage from the dividend cut has now been done. Investors that would have sold on that news have already sold.
And finally, oil stocks in general are cheap and beaten down. Should value investors start to kick the tires on the oil majors, Repsol is going to look attractive.
Oil Stocks to Buy Now: YPF SA (ADR) (YPF)
And finally, for your more speculative capital, I’d recommend Argentine major YPF (YPF).
YPF is a stock that would seem to have everything working against it. It’s located in Argentina, which has been a pariah country for years, and with good reason. For much of its history, the laws of economics have seemed not to apply in Argentina. And as an energy stock at a time of falling oil prices, investors have largely steered clear.
As a result, YPF is set up as a perfect contrarian value play.
YPF is a hated stock in a hated industry in a hated country … that is actually managing to mount an impressive rally. YPR’s U.S.-traded ADRs are up more than 30% from their lows this year. And much of what has made Argentina a pariah state is slowly being addressed. Argentina is settling with many of its holdout bond holders.
Its ongoing feud with the investors that rejected its debt reorganization a few years ago has effectively locked the country out of the global capital markets. Once this gets resolved — and it will — you’ll see capital moving back into Argentina. And YPF should be a major beneficiary.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long BKEP, BP, EPD, ETE, KMI, STO and TK.