We all say the terrifying headlines around oil stocks earlier this year as oil futures actually went into negative territory.
As Hossein Kazemi of the Isenberg School of Management, University of Massachusetts Amherst, explained in an email to InvestorPlace, “A confluence of highly unusual events created the temporary negative WTI oil price on April 20. However, before this day, we had seen an almost 70% drop in crude oil prices over the last 12 months. A combination of a slowdown in the global economy toward the end of 2019, along with a significant rise in domestic oil production in the US and the oversupply of oil by OPEC+ organization created the perfect storm that led to the sharp drop in oil prices from early 2020 until the eventual negative price on April 20.”
But now, oil prices have recovered on a relative basis, with Brent currently trading at around $35. However, economic recovery is likely to be slow and it would be optimistic to expect a surge in energy prices anytime soon.
Therefore, when considering exposure to oil stocks, it makes sense to pick fundamentally strong companies. This column will discuss three stocks that are positioned to navigate the crisis and create shareholder value in the coming years.
From a long-term demand perspective, the following point is worth noting — The oil consumption in the United States was 19.96 million barrels per day in fiscal year 2017. In China and India, the consumption was 13.57 and 4.34 million barrels per day respectively. Considering the fact, the China and India are home to over 2.7 billion people, there is significant impending demand for oil in the coming decade.
Therefore, beyond the current crisis, demand will increase and oil stocks will trend higher. Let’s discuss the following fundamentally strong companies that stand to benefit.
Oil Stocks to Buy: Chevron Corporation (CVX)
As oil prices recover, Chevron stock is already in an uptrend. For investors with a long-term horizon, the stock is worth considering even at current levels.
One reason to like Chevron is the company’s dividend payout of $5.16, which implies a dividend yield of 5.5%. With dividend continuation as a key priority, the stock is attractive for income investors. Importantly, even if Brent trades at $30 per barrel through fiscal year 2020, the company expects its net-debt ratio to remain below 30%. Therefore, strong fundamentals with robust dividends makes the stock among the most attractive in the energy industry.
It’s worth noting that for the first quarter of 2020, the company reported Permian production of 580,000 barrels per day. This represented production growth of 48% as compared to Q1 2019. While Permian production is likely to decline in the coming quarters, the company’s long-term outlook is still robust. In the coming years, the Permian is expected to deliver annual free cash flows of approximately $4 billion.
The company also has assets in the Gulf of Mexico, Brazil and Mexico. This provides visibility for high-impact exploration opportunities and further upside in production.
When Brent trends above $60 per barrel in the coming years, Chevron stock is well positioned to increase dividends and resume share repurchase. With quality assets, production growth visibility and a strong balance sheet, it is a potential value creator.
Equinor commands a credit rating of AA- with Standard and Poor’s and this talks about the company’s strong fundamentals. Even with Moody’s, the company’s credit rating is Aa2. Once the energy sector recovers from the current crisis, Equinor stock is likely to be a value creator.
I am particularly impressed by the company’s long-term action plan. By FY2026, Equinor is expecting break-even oil price at $35 per barrel. Further, between FY2019 and FY2026, the company expects a steady production growth of approximately 3%. With more of its low-break-even projects commencing production, the company’s EBITDA margin will expand as oil trends higher.
As an example, the Johan Sverdrup oil field officially opened on Jan. 7. Currently, the production from the asset is 350,000 boepd with full field break-even at $20 per barrel. Post FY2022, the production from the asset will ramp-up to 690,000boepd. With Equinor holding 42.6% stake in the asset, there is significant scope for value creation and cash flow upside in the coming years.
Another reason to like Equinor is the fact that the company’s focus is on the Norwegian Continental Shelf. Operating in a region with low geo-political risk is a key positive coupled with quality assets. I would therefore look at Equinor as another safe stock for the core portfolio.
In terms of navigating the crisis with a strong balance sheet, BP is another company that looks attractive. As of Q1 2020, the company reported a robust liquidity buffer of $32 billion. Given the current liquidity, the company is potentially financed through FY2021.
In addition, the company’s continued divestment of non-core assets is likely to strengthen the balance sheet. By FY2021, the company has a total divestment target of $15 billion. With these factors in consideration, its not surprising that the company commands a A- credit rating from S&P.
From an asset perspective, the company’s upstream segment will continue to deliver cash flow growth. Further, with steady decline in production cost per barrel, I expect EBITDA margin to remain robust as oil trends higher in the coming years.
I also like BP because of the company’s focus on creating an alternative energy portfolio. While this segment does not immediately impact revenue or cash flows, it’s a possible long-term value creator.
Overall, BP is a safe bet as oil price uncertainty prevails. Even if the crisis prolongs, the company is likely to emerge with a strong balance sheet to grow and create value.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.