Why the U.S. oil sector could reward investors with both returns and yield
Picking winners is getting harder.
In his April issue of Profitable Investing, master income-investor, Neil George noted this market condition, but was quick to point out that good investments are still out there.
Earnings growth is lower and forecast to remain lower in 2019 but rise for 2020. I see a lot of good prospects for specific industries. But there are some challenges to keeping the general market on the boil … That’s why I continue to recommend plenty of income and defensive investments.
… just like there were during the periods of market malaise or selloffs we saw last year, there are always segments and companies that are not just being successful but which also have stocks that are working.
Today, let’s look at one of the sectors Neil is eyeing right now. It’s offering investors the potential for growth tomorrow, while rewarding them with healthy dividends today.
We’ll then reveal one specific company Neil likes which could make a great addition to your portfolio.
***This growth story is happening in our own backyard
With all the excitement and buzz surrounding electric vehicles and solid-state batteries, it can be easy to forget the energy source that’s gotten us here …
Oil.
While alternative energy sources will power our world in the decades to come, oil still rules today — and demand for it isn’t going anywhere anytime soon.
A significant part of global oil production comes from the oil right here in our backyard — what’s called WTI, or “West Texas Intermediate” crude. (This is different than “Brent” crude, which originates from oilfields in the North Sea.)
With that background, let’s turn to Neil from his April issue:
As I’ve been writing over the past year, there are some major developments that favor profitability for U.S. petroleum companies. To start, take a look at the 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 a barrel to a current level of $59.80 a barrel, for a gain of 67.51%.
Now, just to make sure we’re all on the same page, the price of WTI fell off a cliff in 2014 as you can see below.
When this happened, it was a dark time for U.S. oil producers. Many couldn’t remain profitable at those basement oil prices. But there was a silver lining, which Neil explains:
The much lower crude oil prices in 2014 worked to drive U.S. producers and related companies to increase technology in the fields to drive down recovery costs for crude. This means U.S. companies can pump crude at lower costs now, so their margins are strong at lower market prices.
The thing is, now that U.S. producers can make more money on lower prices, U.S. production has soared by more than 33% since 2016.
Neil tells us that this U.S. production growth, combined with OPEC’s adherence to promised production cuts means oil prices are in a sweet spot at the moment.
(U.S. production growth and OPEC’s cuts) will help keep oil prices in a comfortable “goldilocks” range where petroleum companies can make good money and consumers won’t be hit too hard at the pump.
***Even better, the macro situation suggests we’re going to continue seeing strong crude oil prices
In Neil’s issue, he points toward several reasons why this is the case.
First, U.S. stockpiles are down. We’re at lows not seen since last June. Second, Iran remains under sanctions, with no negotiations in sight. Then there’s the chaos in Venezuela. Plus, Saudi Arabia and Russia are past peak production, with the major oil fields in Saudi Arabia actually losing reserves.
At the same time, demand for oil is strong, as Neil explains:
Meanwhile, the globe’s demand for crude oil remains firmly on the ascent. Even with rising U.S. production and exports, there continue to be supply shortfalls relative to global consumption. The EIA tracks overall supply and consumption and, as the graph below shows, demand has outstripped supply consistently over the past many years. Add in the U.S. drop in stockpiles, and the supply and demand statistics favor strong crude oil prices.
***So, how do we play this goldilocks market?
In our February 27th Digest, we suggested you look at MLPs for broad exposure to this sector. From that issue:
After years of disappointing returns, MLPs appear to be carving out a bottom, potentially setting up for gains and big income distributions … Traditionally, MLPs have been an income investment, offering investors huge yields — often in the ranges of the 7%-9% … However, today, we’re looking at the potential for both income and significant price appreciation.
That issue referenced the Alerian MLP ETF, which was yielding nearly 8% at the time. As you can see below, AMLP pushed about 5% higher in the weeks after that Digest. It’s now trading roughly 3% higher as I write.
Even though a broad ETF is a good way to play this sector, there’s one specific company that Neil believes is in a great position to benefit from the additional U.S. oil production — Viper Energy.
From Neil:
Viper Energy is the leading landlord of the petroleum patch, primarily in the Permian Basin. This is the current epicenter of shale oil development in the U.S.
As a landlord, the company doesn’t drill or operate a single well. Instead, it leases out its land for exploration and production (E&P) companies 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 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 natural gas, the higher the royalties it takes in and the higher the income it delivers to investors.
Viper has soared 45% since December 24 of last year. Yet, this doesn’t mean the stock is overvalued at this level. Neil tells us that shares are reasonably valued with a price-to-book ratio of 3.2. This is down from over 4.5 times book last year.
Back to Neil:
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 — not just the stock price.
Meanwhile, Viper gives investors huge income with a 6.11% dividend yield. Plus, this yield has been climbing over the last three years by an average annual rate of over 37%.
Neil likes Viper up to $38, ideally in a tax-free account.
***The stock market is getting more challenging, but that doesn’t mean great opportunities don’t exist
If you like Neil’s take on Viper, he holds a collection of companies with exposure to the growing U.S. oil market — all with healthy dividend yields.You can click here to learn more.
Wrapping up, if you haven’t looked at U.S. oil producers in a while, take a few minutes to give this sector some attention. Picking winning stocks going forward isn’t going to be as easy as it’s been over the last decade. But fundamental strength in the U.S. oil sector puts the odds more in our favor.
Have a good evening,
Jeff Remsburg
