The U.S. economy and stock market has a lot to deal with from the novel coronavirus and the related panic. But that’s not all. Now, the economy must deal with the fallout in the petroleum market, caused by a sudden drop in demand and a hissy fit between Saudi Arabia and Russia.
Crude oil prices are dropping. Brent crude and West Texas Intermediate (WTI) prices have plunged to $32 and $34 a barrel, respectively. Saudi Arabia wanted to make further production cuts to stabilize prices and Russia refused. In response, Saudi Arabia ramped up production and dumped oil from its reserves into the market.
It’s now a full-blown price war.
WTI (White) & Brent Crude Oil Prices
It’s safe to say this is causing mayhem for the U.S. shale oil producers, even in the Permian Basin. There will be a lot of fallout as exploration and production companies face cash and credit crunches. And there will be bankruptcies.
One of my newsletter editor friends is Doug Casey, whom I’ve known since the early 1990s. Casey is the author of numerous books, including the seminal Crisis Investing in 1979. I have an original copy of that title on my bookshelves! Of course, Casey is a fellow newsletter guy in part of the InvestorPlace and Stansberry organization.
He has always been one of the smarter guys in the room — particularly when it comes to finding bargains in the markets. One of his tenets is to buy when there’s blood in the streets.
Buy Energy Stocks When There’s Blood in the Streets
I have always marveled at how Doug Casey can take a market that’s in trouble, pick through the facts, toss away the fear and come away with a rational case for buying. And in turn, I marvel at watching as the facts play out, rewarding him with gains and often lots of income along the way.
This makes for a bit of a “blood in the streets” case for the energy market.
Right now, companies are evaluating their wells in terms of revenue and operating costs. And when they can, they will move to operate at maintenance levels. This is lowest level of production — a step above completely shutting off the well. But operating at maintenance levels keeps companies from incurring capping and cleanup costs.
Here, cash burn rates are very important for the companies and their creditors. But in the end, outside of the pandemic’s impacts to demand, the fields and equipment will still be there.
I see that U.S. production will be curtailed and that it will result in a supply-demand imbalance. After the current crisis, crude oil will return to higher levels. Natural gas is still a basic necessity for utilities and petrochemical industries, so it will find support.
Oil Futures Are Looking Up
One of the interesting parts of the oil market is that while spot prices are down, future delivery prices are still higher in the futures markets and modeled future fair values.
U.S. WTI Forward Price Curve
What does this mean? It points to the fact that oil isn’t going away — in the U.S. or around the world. And it means that major consumers are buying crude oil. The market is providing values for crude oil after the Russia-Saudi price war resolves and the outbreak clears up.
Demand for refined products has dropped significantly as car travel is down, as is air travel. So, refiners get cheap feedstock, but fewer customers and demand.
The pipelines still have demand for their pipes. But revenue growth is not going to happen for a while — until well after the virus crisis.
And then there’s the counterparty risk. With crude oil producers under extreme duress, expect an impact to pipeline contracts. The bigger pipes will make it through as they have during other difficult times.
How to Measure Petrol Risks and Opportunities
How do I evaluate the broader petroleum stock market and individual energy stocks? I look at them based on status. This means I am looking at their underlying assets, including cash, and broader measures of company value.
By looking at the general assets less the liabilities of companies, we can get closer to their intrinsic value. And dividing that against the number of common shares gets us to the price-book valuation, as well as the weighted value for the S&P Energy Index.
Right now, the price-book ratio of the S&P Energy Index is sitting at 0.9 times, meaning that energy stocks are trading at a 9% discount to their underlying intrinsic values. This is way lower than the recent high (from 2018) of 2.2 times. This means that after the selloff, stocks in the index have dropped in per-share valuation by 57.7%.
And now, this value is below its five-year lows.
S&P Energy Index Price-Book Ratio
Of course, when measuring the book value and the P/B ratios, we rely on company disclosures.
During this time of extreme economic stress, assets will be valued on a varied basis. But it is a good tool to work on the status of the market and individual companies. Over the past three years, the underlying book value for S&P Energy Index members has been climbing by a compound annual growth rate (CAGR) of 1.1%, even with the first-quarter challenge.
So it’s clear there’s value in the underlying energy stocks. As we get through this, sales and earnings will follow. But more important to get to the status of each company is its debts.
I always look at the balance sheets of companies before I recommend them. As I mention from time to time, if I wouldn’t lend a company money, then I don’t have business recommending its stock. Remember, I’m a former banker and bond guy.
So, in the past weeks, I’ve been going through many petrol companies and their debts. Moreover, I have been evaluating their cash and available liquid assets. It’s important to determine a company’s ability to service its liabilities for the coming year. And I have also been examining the debt structure from bank loans, lines of credit, bonds and preferred shares, if used.
In turn, I have then looked at the debt service needs and capabilities, and whether each company has to rollover or renew loans, credit lines or bonds.
I also make sure to look at each company’s dividend commitments.
Pulling My Energy Stocks Research Together
My goal here is to create a judgement on the sustainability of each company. Is it able to get through this mess and survive on the other side? These decisions allow you to own good stocks of tough companies.
Then, I go through post-crisis estimates of how each company should emerge. While revenue and earnings estimates are very hard to model, I’ve been looking at the underlying business models to make sure that each company will continue to be relevant and successful.
This also means that I evaluate their customer bases and suppliers. My overall goal is not just to tell you that a stock is cheap, but to tell you its survival chances. After I do all of this, I go through my model portfolios and holdings to answer these questions.
There are more than a few energy stocks that are good to get through the current challenges. And in turn, these companies will generate more sales, profits and dividends.
Energy Stocks to Buy: Viper Energy (VNOM)
A lot of the petroleum market is based on exploration and production (E&P) companies. But there is another way to buy bargain energy stocks, and with a lot less uncertainty and risk. Buying land rich in underground petrol is a cheap project. This is where my first recommendation comes in.
Viper Energy (VNOM) Dividend Distributions (Orange) & Yield (White)
Viper Energy (NASDAQ:VNOM) is the landlord of the Permian Basin. It has piles of cash, and cash alternatives, amounting to 5.4 times its current liabilities. The company doesn’t explore or produce — it only leases out land and collects rent and royalties. Its debts are meager at 21.1 times assets. Viper energy has a bond maturing in 2027, a smaller loan maturing in 2022 and a credit line with Wells Fargo (NYSE:WFC) due late that same year.
The risk to VNOM stock is that its tenants continue to slow production, which would mean less revenue for dividend payouts. But the bigger risk is that tenants abandon the wells, creating liabilities for the company. But its primary tenants are longer-standing companies, and Viper has the backing of Diamondback Energy (NASDAQ:FANG).
Shares of VNOM stock are now valued at book value, which will likely be written down as oil prices continue to drop. But Viper has a lot of land filled with a lot of oil and gas.
VNOM stock is relatively new, and has less history than other energy stocks in this report. That said, it does have an impressive history of delivering distributions for ample yield.
Finding Other Bargains: Look at Pipes and Infrastructure
Then I come to the pipelines. When it comes to cash flow and dividends, pipelines traditionally are the lower-risk segment of the market. These companies are less susceptible to price risk than producers.
In addition, pipelines are heavy cash generators. They pay ample dividend distributions and make great income investments. And over time, they have a track record of delivering sustained, positive total returned. Over the past 20 years the Alerian MLP Infrastructure Index has generated an annual equivalent return of 8.4%, including 2020 year-to-date.
One of the more dependable segments of the energy market is the pipeline industry. This segment acts as a toll-taker to gather and transport oil. It goes from the field to the end users, which include refineries and consumers.
Oil and gas prices rise and fall, but as long as the pipes are filled, companies earn their fees. In turn, they share the bulk of the profits with their shareholders. The real risk for pipe companies is managing counterparty risks.
The best in this segment have been around during the boom and bust times of oil and gas prices. And so, it is pretty straight-forward to examine how they fared during times of stress.
Enterprise Product Partners (EPD)
Enterprise Product Partners (EPD) Total Return
One of my favorites in the pipeline space continues to be Enterprise Product Partners (NYSE:EPD). The company is on the forefront of solving the key problems in the U.S. It is working to get more of the products from the fields to the markets — including for export.
Enterprise has been expanding its capabilities and just announced this month that it is working with Enbridge (NYSE:ENB) to develop a deepwater oil expert terminal in the Gulf of Mexico.
The selloff hit EPD hard. Yet, it has a long history of delivering to shareholders. The average annual equivalent return for the trailing 20 years is 12.7%. That’s including the recent plunge.
Enterprise Products has controlled debts and managed cash flows. This enables the company to work through the current troubles.
Magellan Midstream Partners (MMP)
Magellan Midstream Partners (MMP) Total Return
One of the key challenges in the MLP space is that there are plenty of companies that are not as strong as Enterprise. Many are consolidating, and others are converting to regular corporations to allow a broader investor base.
In addition, there are a growing number of funds circling the midstream space as a value proposition.
This is particularly true in specific pipeline sectors such as refined products. One of the big developments is due to marine fuel standard changes, as part of a new lower sulfur regulation. These new regulations are providing opportunities or pipes, storage and marine terminals as the world emerges from economic lockdown.
Those opportunities also extend to diesel, gasoline and jet fuel companies. These companies are down dramatically, but they will be ins stronger demand after the lockdowns ease.
This is where Magellan Midstream Partners (NYSE:MMP) comes in. It is one of the best in the refined space. MMP provides transportation, storage and distribution of refined petroleum. this means gasoline, diesel, jet and marine fuels. Remember that demand for refined products will rebound.
Magellan traditionally had lots of regular cash flow, so it has kept less cash on hand. And, its debts are higher at 57.8 times assets as it is a capital-intensive company that is essential for the U.S. economy. Its bonds are largely placed in longer maturities, and it has two major credit lines.
MMP shares have had an impressive history of delivering return to shareholders since entering the public market back in 2001. The average annual equivalent return since then is 17.1%.
Alerian MLP ETF (AMLP)
Alerian MLP Infrastructure Index Total Return
This brings me to the Alerian MLP ETF (NYSEARCA:AMLP), an indexed investment on the front line of sellers. But this is not reflective of the performances and fundamentals of its core holdings. And EPD and MMP dominate that list.
This provides a further opportunity to buy into the discounted MLP market. The Alerian MLP ETF yields a big dividend of 20.3% overall.
As noted earlier, the main Alerian MLP Infrastructure Index has historically generated ample returns for shareholders. AMLP tracks the primary pipes and related companies in the index.
The petrol market might not be done with its challenges. But the economic lockdowns will lift, and there are ongoing negotiations between Saudi Arabia and Russia. So, investors looking through the current strife will find bargain energy stocks in the current blood-in-the-streets market.
Neil George was once an all-star bond trader, but now he works morning and night to steer readers away from traps — and into safe, top-performing income investments. Neil’s new income program is a cash-generating machine … one that can help you collect $208 every day the market’s open. Neil does not have any holdings in the securities mentioned above.