[Editor’s note: This story was previously published in September 2018. While the author’s position may have changed, the energy stocks remain relevant.]
Oil is back.
In 2014, WTI crude oil prices were north of $100 per barrel. Not surprisingly, energy stocks, and in particular oil stocks, were doing pretty well back then. But, oil stockpiles got too high at the same time that demand started to waver. The oil market was left with this massive oversupply glut, and that sent oil prices tumbling. By early 2016, WTI crude oil prices had fallen to below $30 per barrel.
Energy stocks dropped, too.
Now, after years of being stuck in neutral, oil prices are making huge comeback. WTI crude oil prices are back above $50 per barrel as production cuts from OPEC and others have coupled with a pick-up in the global economy. Potential U.S. sanctions on Iran have also helped the price of oil lately.
Overall, the backdrop is favorable for rising oil prices. In that backdrop, investors want to own energy stocks. In particular, they want to own oil stocks.
But, in that world, there are ton of stocks — and, not all of them are high quality. As such, here’s a list of my three favorite energy stocks to own as oil prices break higher.
Energy Stocks to Buy: Exxon Mobil (XOM)
My favorite pick in the energy sector for rising oil prices is Exxon Mobil (NYSE:XOM).
Historically speaking, XOM stock tends to track oil prices pretty closely. As oil prices fall, so does Exxon. As oil prices rise, so does XOM stock. That makes sense. After all, higher oil prices mean higher prices at the pump, and higher prices at the pump mean more revenue and profits for Exxon.
This could be especially true now. The U.S. economy is as strong as it has been in a while. Thus, higher gas prices won’t really be a death blow to super-confident consumers, and they will likely embrace higher prices at the pump. That means consumers should fuel up in just as great frequency as they have over the past several years, just at higher prices.
That is a big win for Exxon.
But, the best reason to own this oil stock isn’t because higher prices at the pump will drive the stock higher. It is because even if that doesn’t happen, Exxon Mobil stock is supported by a strong global brand, a huge moat, a resilient investor base, and a healthy 3.9% dividend yield. Thus, even if oil prices stagnate and/or fall, XOM stock shouldn’t fall by much. Historically speaking, it hasn’t, and considering the stock’s five-year low is only 15% below current prices, downside risk even in a worst-case scenario seems limited.
All together, the risk-reward on Exxon stock is highly favorable here. At worst, this stock loses 15% over the next several months, but that seems next to impossible given rising oil prices. More realistically, those rising oil prices continue to push XOM stock higher, and we get back to five-year highs of around $100.
Energy Stocks to Buy: Halliburton (HAL)
Another top pick of mine among oil stocks is Halliburton (NYSE:HAL).
A widely recognized and widely followed oil services company, Halliburton naturally tends to perform well when oil prices are rising and perform poorly when oil prices are falling. This trend has been true for the past decade, with changes in HAL stock closely tracking changes in the price of oil.
But, that trend has broken recently. Year-to-date, WTI crude oil prices are up more than 10%. HAL stock is down 19%.
Why the huge divergence? Various headwinds are weighing on Halliburton’s operations and diluting near-term earnings power. Most of them are company-specific and should pass, such as production bottlenecks and near-term adverse pricing conditions. Although these headwinds are hurting earnings power now, they won’t dilute earnings power forever.
As such, this looks like a dip worth buying in Halliburton stock. From a history viewpoint, HAL stock dropping 20% in 2018 while oil is up more than 10% is an unprecedented divergence. Granted, you don’t want to buy a falling knife. But, Halliburton recently held the $35 level and has since strongly reversed course, implying that this falling knife is no longer falling and may be due for a rebound.
Overall, HAL stock is one of the better energy stocks to own right now because it has been killed despite rising oil prices, a disconnect which simply cannot persist for that much longer. Plus, the stock’s 1.8% dividend yield isn’t great, but it’s enough to pay investors while they wait for the turnaround.
Energy Stocks to Buy: General Electric (GE)
Much like Halliburton, industrial conglomerate General Electric (NYSE:GE) has been a falling knife despite an economic backdrop that would imply higher prices for industrial stocks. But, also like Halliburton, this weakness should only be temporary.
There are many reasons why GE stock dropped to multiyear lows — the biggest being mismanagement. Essentially, the downfall of GE was brought on by mismanagement of an overly complex business with a ton of debt and a significant lack of focus and innovation.
Those errors are now in the process of being corrected.
Most importantly, the company is simplifying its business model to include only three core components: Aviation, Power and Renewable Energy. Everything else, including Healthcare, will be spun out of the GE umbrella. The removal of these businesses will allow the company to significantly reduce its debt load, take huge costs out of the operating model, and focus on pushing innovation more quickly through its remaining business segments.
Overall, then, GE is making all the right moves. It is simplifying the business model and reducing leverage. And, it is narrowing its focus to three operating segments with long-term, stable growth prospects.
These steps won’t yield immediate benefits, but over time, revenue growth should stabilize, and margins should head materially higher. Debt reduction should flow into improved profitability through lower borrowing costs. Then earnings, and GE stock, should bounce back in a big way.
As of this writing, Luke Lango was long XOM.
