Editor’s note: This column is part of our Best Stocks for 2019 contest. Neil George’s pick for the contest is Viper Energy Partners (NASDAQ:VNOM).
The InvestorPlace stock picking contest for 2019 is a showcase of ideas from the collection of editors and contributors. And it also demonstrates the process each different person uses to come up with a company.
My recommendation is for Viper Energy Partners (NASDAQ:VNOM), which year to date is up in price by 27.7%. And with its dividend yielding 6.1%, the total return to date is over 29%. This compares to the price gain of the S&P 500 Index of 12.8% and a total return of 13.4%.
Viper Energy Compared to the S&P 500 Index Total Return Source Bloomberg
This contest isn’t about throwing darts but showcasing how ideas are generated and why. And in the process, throughout the rest of the year, you’ll get a better feel for how each of us work.
At Profitable Investing, one of my core mechanisms for finding the best stocks for growth and income is finding economic, market or even social or political developments that will spur more demand for specific goods and services.
I do this by consuming a great deal of news from numerous daily papers, constant streaming of BBC World Service and Bloomberg Television, subscribing to many industry and professional journals and, of course, being glued to my Bloomberg Terminal with all of its analytical and data tools.
When I find some developments that support more demand, I drill down and find the companies that are best focused to capitalize on that pending new demand. Then I identify the leaders and vet them to find the best of the best. I go through those to determine which will be sales growth leaders while watching for those with the best and most improving margins. After that, I ask what will go wrong to dampen future sales or result in higher costs. And I run what ifs to see how they will cope with challenges. And finally, I put my banker hat on and look at the debts of the companies.
At the end of this process I determine if I would lend to this company. And if not, then I have no business recommending it as a buy for you.
Viper Energy ticks all the boxes in a market with positive developments. And as a landlord of the petroleum market — it is a unique company in that it doesn’t drill or operate oil and gas equipment — only collecting lease income and royalty payments.
Read on to see how and why I recommend the company and its stock.
Petrol is Powerful
Petrol is a big part of the U.S. and global economy, and that’s why we have a collection of up, down and midstream petroleum companies inside the model portfolios of Profitable Investing. And like most market segments, the market for petroleum and the underlying companies and their stocks never moves in a continuous straight line.
But as I’ve been writing in Profitable Investing this year and over the past year, there are some major overriding developments that favor profitability for US petroleum companies. And to start, all it takes is to look at price of U.S. West Texas Intermediate (WTI) crude oil. Since 2016, the market for U.S. crude oil has gone from a low of $35.70 to a current level of $60.01 a barrel for a gain of 68.1%.
US WTI Crude Oil Price Source Bloomberg
The price, of course, was higher in October, but with the sell-off in the general stock market, oil slipped to a near term low on Dec. 24 — corresponding to the lows in many of the stock market indexes.
But like for stocks, the realities of a growing U.S. economy and profitability of U.S. oil companies at even lower crude prices has been supporting the underlying market. And note, as I’ve written, the much lower crude oil prices five years and more ago worked to drive U.S. producers and related companies to increase technology in the fields to drive down lift costs for crude. This means that U.S. companies can pump crude at lower costs so that margins at sale can be positive even with lower market prices.
This had been leading to a continued upward march in U.S. production, which since 2016 has soared by more than 33%.
US Crude Oil Production Keeps Climbing Source Bloomberg
And according to the U.S. Energy Information Administration (EIA), this continued climb in production should result in that the US will be a net oil exporter by 2021.
Adding to the positive market developments are that the Organization of Petroleum Exporting Countries plus Russia and other nations (OPEC+) continue to largely adhere to production cuts, resulting in the proven data from shipping records of December 2018 showing production cuts of 1.2 million barrels per day (MBPD), with only Russia and Iraq showing some slippage in their cuts.
More Crude on the Move
What has been a limitation for U.S. crude has been domestic stockpiles of stored crude. One of the big limitations has been the infrastructure to move crude to refineries and marine terminals for export. But as I’ve been writing, the approval process for additional pipeline capacity has been stepped up with pipeline companies continuing to add capacity to move stuck crude to the market.
This now is showing up with the dramatic drop in U.S. stockpiles of crude as tracked by the EIA. The stockpiles are now down to lows not seen since last June and may well head lower with the further developments in transportation.
US Crude Stockpiles Down West Texas WTI Up Source EIA, Bloomberg
This drawdown in stockpiles is showing up in the export market. And what is particularly interesting is how much more U.S. crude is being shipped to Europe. Over the past five years, U.S. crude exports have gone from zero to nearly 1.4 billion barrels according to records from the U.S. Census Department.
US Crude Exports to Europe Source US Census, Bloomberg
This surge in U.S. crude in Europe is now driving the price of European crude prices. For North Sea crude prices set at ports in the Netherlands, Argus Media (Private), a business intelligence analytics company, is stating that one third of the time, U.S. crude imports in Europe are driving the prices for European crude oil.
That puts U.S. producers further on the way to narrowing the price discount of WTI in the U.S. to the higher Brent crude prices. And this in turn, should help to increase the margins for U.S. producers and related companies.
Globe Takes More than Makes
Now, OPEC+ isn’t going to limit production forever. However, there are some reasons to see limits in their capacity to bring significantly more crude oil to the market. First, Iran remains under U.S. sanctions with no daylight in negotiations in sight. And waivers are running out, particularly with more availability of U.S.-exported oil such as what is now surging to Europe and noted above.
In addition, even if other major former producers get sorted out politically — they will take years to get back into the oil business. This includes the imploding nation of Venezuela, the broken-apart Libya as well as the very unsettled West African nations including Nigeria.
Second, as I wrote in the September Issue, Saudi Arabia and Russia are both post peak in production with the major fields in Saudi Arabia being drained with dropping reserves.
Meanwhile, the globe’s demand for crude oil remains firmly on the ascent. And even with rising U.S. production and exports, there continues to be shortfalls in supply against global consumption of crude oil. The EIA tracks overall supply and consumption and as the graph shows — consumption keeps peaking over supply on an ongoing basis over the past many years.
And add in the U.S. drop in stockpiles — and the supply and demand statistics favor supported crude oil prices.
Global Oil Supply (White) Global Oil Consumption (Gold) Source EIA Bloomberg
My Permian Play
There are many companies, from upstream producers through midstream pipelines and downstream refiners, that are benefiting from the petroleum market developments that are underway.
But the company that is right at the source of all of this additional U.S. production of oil and gas is Viper Energy, which I hold in one of the model portfolios of Profitable Investing.
Viper Energy is the leading landlord of the petroleum patch primarily in the Permian Basin which is at the center of the shale oil development in the U.S. market. As a landlord, the company doesn’t drill or operate a single well — but instead, leases out its land for exploration and development companies (E&P) for fee income and royalties on the oil and gas that gets pumped out of its land.
This means little capital is needed beyond the land. And it means that the company doesn’t have to worry as much about the price fluctuations in oil and gas for its operations. But of course, the higher the price of crude and the higher the price for natural gas — the higher in royalties and the higher the income.
It has a large collection of operators on its land including Devon Energy (NYSE:DVN), BP (NYSE:BP), XTO Energy, EOG Resources (NYSE:EOG), ConocoPhillips (NYSE:COP), Occidental Petroleum (NYSE:OXY), Anadarko Petroleum (NYSE:APC) and many others. Each and all continue to develop leased properties.
Since coming to the public market in 2014 through a drop-down of assets from Diamondback Energy (NASDAQ:FANG) in which it took land assets and set up Viper to manage and own the properties while taking and keeping an ownership stake in the company, the proven developed reserves of petroleum have climbed by 764%. And royalty income per acre of its land has grown by 368%.
Overall oil and gas produced on Viper’s land was up 63% in 2018. And the company is projecting that on an organic basis (meaning existing land statistics and not counting additional land and land development that production will climb at least by 24% for 2019.
In addition, Viper completed an extra share sale this year. That additional cash is going to expand its land properties. And with Diamondback having much more land it its existing assets — there is more room for a further drop down for more productive petroleum land in its portfolio. This will mean more growth potential for leases and royalty income.
Venom Stock for Better Returns
Total Return for Viper Energy Source Bloomberg
Viper Energy has been a good performer. Over the trailing year, the stock has generated a total return of over 58%, including its ample and rising dividend. And this even includes the slip with the general stock market in the fourth quarter of last year.
But since Dec. 24, 2018 to date, Viper has soared by 46% reflecting the realities of the economy and the market for high and rising royalty income from its leased lands.
VNOM Stock by the Numbers
Viper, as noted above, is working well as a landlord. Revenues for the trailing year are up by 67.90%. And since it doesn’t drill or pump oil — its operating margin is a whopping 70.30%. This in turn drives a great return on shareholders’ equity of 20.60%. It has gobs of cash and its debts are at a minimal 24.8% of its valuable assets so its credit is very good.
Then we come to that nice dividend. The current distribution is at 51 cents which has been climbing over the last three years by an average annual gain of 37.32%. That distribution equates to a yield of 6.19%. And in recent tax filings, even though Viper changed from a passthrough to a taxable entity effective on May 10, 2018 the dividends paid on August 20 and November 19, 2018 have been deemed as return of capital.
The stock has been performing and paying well. And yet, the shares are reasonably valued with a price to book at nearly 3.19 times. This is down from over 4.5 times book seen earlier last year. And more important, the underlying book value per share has climbed over the past year by 36.36% meaning that the underlying value of the book of assets is up and growing and not just the stock price.
Now that the additional shares have been placed in the market successfully, the stock makes for a continued good buy for growth and income under $38.00 per share.
Neil George is the editor of Profitable Investing and does not have any holdings in the securities mentioned above.