In a volatile year for the stock market, energy stocks have been some of the worst performers. They crashed as hard as any other sector in March. Then, the decision of Saudi Arabia to launch a price war added more problems to a sector that was already in shock. And in the subsequent recovery, energy has badly trailed the pack.
However, things might finally be changing.
Energy stocks have moved higher over the past few weeks, even as tech names and other leaders have struggled. For the first time in awhile, so-called value stocks are making a move, with energy leading the pack. Notably, this comes even while the actual prices of crude oil and natural gas remain subdued.
As such, we could be at the beginning stages of a profitable move in this out-of-favor sector. There is an interesting opportunity here for buyers willing to get in before the momentum becomes obvious. On that note, these are the seven best energy stocks to close out 2020:
- Canadian Natural Resources (NYSE:CNQ)
- Suncor (NYSE:SU)
- Exxon Mobil (NYSE:XOM)
- Valero (NYSE:VLO)
- Enbridge (NYSE:ENB)EN
- TC Energy (NYSE:TRP)
- Ecopetrol (NYSE:EC)
Energy Stocks: Canadian Natural Resources (CNQ)
Canadian Natural Resources is not the most-well known company on this list. However, it gets the first spot here because it is the most promising of all the energy stocks.
Simply put, if you want an energy producer that can survive an oil market apocalypse and come out stronger, Canadian Natural should be your pick.
What makes Canadian Natural stronger than all the other oil companies — even the major integrated firms like Exxon? Production costs are the answer. Canadian Natural is the cheapest producer, coming in at just $31 per barrel all-in, and it has the longest-lived resources. Add those two facts up, and you have an unassailable strategic advantage.
Now, to be fair, other stocks on the list could easily outperform Canadian Natural in coming months and years. Because Canadian Natural has rock-bottom operating costs, its balance sheet is not in question. In fact, it can easily produce its current level of output and pay its existing dividend at $40 per barrel of oil for many years to come.
Thus, this is not the company to go heavily in on if you think oil is going back to $70 or $80 per barrel next year. However, if you want a safe, high-quality energy stock with exemplary management and minimal downside risk, you can’t get any better than this.
Suncor is right in the same ballpark as Canadian Natural. Like its peer, Suncor is also a big player in the Alberta oil sands. But Suncor doesn’t have quite as enviable a cost structure. To make up for that shortfall, Suncor has a ton of refining capacity. This insulates it from Western Canada’s low oil prices and allows it to get a fair profit margin on its crude. It also gets four-fifths of its crude from the ultra-low-cost oil sands production areas.
Heading into the Covid-19 crisis, Suncor produced nearly 800,000 barrels of oil a day. That is not all. In fact, Suncor produced more than half its earnings last year from its refining and gas station units. Unlike U.S. refining, which has seen margins slip recently, Suncor has traditionally retained fat refining profit margins thanks to the larger spread between crude and finished product prices in the Canadian market.
The final piece of the puzzle is capital allocation. Suncor has never been prone to empire-building.
Rather, it has kept a tight focus on its world-class oil sands operations. When it has excess cash — which it often does thanks to its lean operations — it spends it on share buybacks or increasing the dividend. Prior to Covid-19, analysts had anticipated annual 10% dividend hikes for many years to come. That future has been delayed a bit, but it should come back in full force within the next couple of years.
Energy Stocks: Exxon Mobil (XOM)
Exxon Mobil is hotly debated and not without its faults. Management got a bit side-tracked over the past decade on sub-optimal projects such as a big bet on American natural gas. Some of these efforts failed. In addition, the crash in oil and gas prices has caused a cash flow imbalance. Exxon is spending heavily on expansion at a time when it has its lowest cash flows in decades.
This may lead to a temporary reduction in its current eye-popping 9% dividend yield. For income investors, a dividend cut is an unthinkable sin from Exxon. After all, the company has hiked its dividend annually dating back to the 1980s. A dividend cut would be sacrilege.
While the short-term pain is undeniable, however, little has changed in the long run. Exxon has some of the world’s best oil reserves. Among these, it just brought online a game-changer new oil field off the coast of Guyana. Over time, Guyana appears poised to become a huge oil producer, with Exxon reaping the windfall profits. Exxon has a ton of other investments in the works as well.
These may not come quickly enough to save the dividend this year, but make no mistake. Over the next three to five years, Exxon will again become one of the world’s most profitable companies. Why pick up the stock now if the turnaround isn’t immediate? The potential dividend cut is old news at this point. XOM stock could surge soon as traders move past the obvious bad news and start looking at Exxon’s rising outlook.
Admittedly, U.S. refining is not quite as good of a business as Canadian refining, at least recently. However, leading U.S. independent refiner Valero earns pretty decent profit margins in its own right. It has several well-situated refineries that have allowed it to profit from the fracking boom, as they sit near the flood of crude coming out of West Texas.
Valero is currently not earning much of anything. The collapse in gasoline, jet fuel, asphalt and various other refined products demand simultaneously has been a crushing blow for the outlook in 2020.
Going forward, however, there is hope. As the economy comes back, so will Valero. Analysts see 2022 earnings topping $6 per share, which would put VLO stock on a 7x price-earnings ratio.
Notably, management continues to pay out nearly $4 per share in annual dividends, which amounts to a 9% dividend yield. Investors can enjoy a fat yield now and a big stock price rebound going forward as transportation starts to rev up again.
Energy Stocks: Enbridge (ENB)
My next two picks, like Suncor and Canadian Natural, are another set of Canadian peers. Enbridge and TC Energy are the two largest players in pipelines in North America. Why go with the Canadian names instead of U.S. pipeline operators?
There are a few reasons. For one, both Enbridge and TC have much better management. The pipelines, in particular ones in master limited partnership (MLP) format, have been a fiasco in the United States. Excessive fees, huge leverage and misaligned incentives caused most American MLPs to crash and burn.
Enbridge, by contrast, is a normal corporation and has been for many years. In addition, it never went wild with debt, and thus has been able to have a steady, slowly rising dividend over the years. That is a huge difference from most pipeline firms.
Notably, the Canadian political environment has been more difficult in recent years. That may seem like a negative at first glance, however it is actually a plus. From here, the odds favor Canada becoming more energy-friendly going forward. Meanwhile, depending on election results in November, the U.S. could take a turn toward more restrictive policies.
Add it all up, and the biggest pipeline company is also the best. Enbridge’s dominant pipeline network and juicy 8% dividend yield should definitely be on your radar.
TC Energy (TRP)
TC Energy shares many of the same favorable characteristics with Enbridge. However, management deserves specific credit for a shrewd move it made this week.
TC Energy is offering to buy out its publicly traded MLP subsidiary, TC Pipelines (NYSE:TCP), for just $27 per share. This will be an incredible deal for the parent TC Energy. TCP stock traded for as much as $50 a few years ago. Now it is being acquired for just half that. Incredibly, TC is buying out its subsidiary at just an 8x P/E ratio. The TC Pipelines shareholders can complain, but it seems they’ll be unlikely to stop the deal from happening.
In any case, such is how things go during industry busts. Those with the gold make the rules. The giants with strong balance sheets like Enbridge and TC Energy are ravenously eyeing the marketplace, seeing what assets they can gobble up on the cheap. Then, when another energy bull market arrives, the newly enlarged titans will produce larger-than-ever profits and dividends.
Make no mistake, the demand for oil and gas pipelines is not going anywhere over the next 20 to 30 years. And in TRP stock, you have a company already paying a 6% dividend that is building its network by buying up other pipelines at rock-bottom prices.
Energy Stocks: Ecopetrol (EC)
Ecopetrol, for those unfamiliar, is the Colombian state-led oil company. While it is primarily owned by the Colombian federal government, it listed a minority position in its shares on the New York Stock Exchange in 2008. Now, why would you want to invest in Ecopetrol?
For one, Colombia is a surprisingly competent oil producer. Given the problems neighboring Venezuela is having lately, Colombia actually overtook that famed oil power. At a million barrels of oil per day, Colombia now trails only Brazil and Mexico in the ranks of Latin American oil producers.
In good oil markets, state oil companies tend to underperform fully private peers. In down markets, however, the state is a benefit. Ecopetrol is largely insulated from competition. It is also Colombia’s largest listed company by market capitalization. Ecopetrol generally pays a large dividend, and since most of that goes to the government with its majority shareholding, Ecopetrol is a vital piece of the government’s revenues.
As such, Colombia has given Ecopetrol wide latitude to control gas stations, pipelines, refining operations and other pieces of the oil and natural gas supply chain.
Ecopetrol will remain considerably profitable this year. And in 2021 and 2022, analysts see earnings rising to 95 cents and $1.21 per share, respectively. That amounts to a 10x and then 8x P/E on the current stock price. When oil rallied from $30 to $75 from 2016-onward, EC stock quintupled off the lows. Don’t be surprised if it makes another multi-bagger move the next time oil finds some traction.
On the date of publication, Ian Bezek held long positions in XOM, SU, CNQ, ENB, and TRP stock.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.