Energy stocks lagged as the markets moved higher in the November rally. In 2023, the energy sector has underperformed in the S&P 500, with the Energy Select Sector SPDR Fund (NYSEARCA:XLE) down 3% year-to-date. However, the best energy stocks to buy are bargains, considering their robust free cash flow generation and valuation discount.
Generally, energy stocks are correlated to oil prices. At these prices, the best energy stocks have downside protection. After a rapid drop from over $95 per barrel to below $80, oil prices are at the bottom of their range. Moreover, several factors are likely to support oil prices going forward.
First, on Nov. 30, OPEC announced voluntary production cuts of 2.2 million barrels per day. These cuts will stabilize oil prices. Prices can hold up if global oil markets are undersupplied going into 2024.
Secondly, the Biden administration is looking to refill the Strategic Petroleum Reserve. On Nov. 30, the Department of Energy announced a 2.7-million-barrel purchase at an average price of $79 per barrel. These efforts to replenish the SPR will support oil prices at this level.
If oil prices stabilize at these levels, energy stocks will perform well. Since most energy stocks are profitable at $50 per barrel of oil, profits and free cash flows will be robust. Buy the following energy stocks for gains in 2024.
EOG Resources (EOG)
EOG Resources (NYSE:EOG) has been one of the best oil operators in the U.S. It’s North America’s third largest energy producer. Moreover, the oil giant has best-in-class assets in the Permian and Eagle Ford.
The investment thesis for EOG Resources is based on its high-quality assets, low operating costs and pristine balance sheet. It has some of the lowest finding and development costs among energy stocks in North America. As a result, it generates double-digit returns on capital employed.
Over the past decade, its Permian assets have driven production growth. However, well productivity has declined from 2021 levels. Fortunately, the firm thinks its 430,000 acres in the Utica shale will be the new source of premium returns.
As third-quarter results showed, this oil producer is still growing production. Total production averaged 998.5 thousand barrels of oil equivalent per day, an 8.5% year-over-year increase. Besides volume growth, EOG Resources reported lower per-unit operating costs.
In terms of shareholder returns, management has committed to returning at least 70% of annual free cash flow. The company has returned $4.1 billion of free cash flow year-to-date in line with this pledge. In the third quarter, it bought back 61 million shares and increased the dividend by 10%.
For 2023, management expects production growth across crude oil, natural gas and natural gas liquids. Analysts estimate $12.05 in EPS for the whole year. Thus, the stock trades at 10 times 2023 earnings.
Permian Resources (PR)
Over the past year, there have been a lot of mergers and acquisitions among energy stocks. Chevron (NYSE:CVX) acquired Hess (NYSE:HES) in a $53 billion deal and Exxon Mobil (NYSE:XOM) acquired Pioneer Natural Resources (NYSE:PXD). Even smaller players haven’t been left out. For instance, Civitas Resources (NYSE:CIVI) purchased oil assets from Vencer Energy in a $2.1 billion deal.
Considering the heightened transaction activity, focusing on energy stocks that could be acquisition candidates could yield solid returns. In the current environment, energy stocks with good oil and gas reserves are likely targets.
Truist analyst Neal Dingmann thinks that Permian Resources (NYSE:PR) is a likely candidate. In a CNBC interview, he highlighted that the company had great assets, making it a potential acquisition target.
Permian Resources is also a good candidate based on valuation since it’s very cheap. As of this writing, it trades under 3 times forward-12-month EBITDA. Also, the stock trades at a discount to the overall sector on forward PE, at 10 times forward earnings.
TipRanks analysts also view the stock as undervalued and expect further upside. The average price target is $17.50, presenting an upside of over 30%. Even without an acquisition, PR stock has upside. Production and free cash flow will grow as it integrates the Earthstone Energy acquisition. Either way, PR stock is one of the best energy stocks to buy.
Phillips 66 (PSX)
Phillips 66 (NYSE:PSX) is one of the energy stocks in the headlines lately. On Nov. 29, CNBC reported that Elliott Investment Management had taken a $1 billion activist position in the company. They noted that the activist investor would be pushing for seats on the board.
The activist pressure comes amid Phillip’s underperformance versus its refining peers, Marathon Petroleum (NYSE:MPC) and Valero Energy (NYSE:VLO). Elliot could be critical in turning around the company. Notably, they had prior experience in the industry with their activist campaign in Marathon Petroleum in 2019.
For now, it appears that Phillip’s management is open to Elliott’s perspective. In their response, they acknowledged they had talks with the activist investor and were open to more constructive dialogue.
Furthermore, management highlighted other actions they were taking. Strategically, they plan to monetize over $3 billion of non-core assets. Additionally, they expect to achieve $1.4 billion in savings by year-end 2024.
Regarding shareholder returns, they will raise distributions from $13 billion to $15 billion. As of this writing, the refiner has a dividend yield above 3%. These increases will improve shareholder returns going forward.
With management on its toes due to activist pressure, PSX stockholders will see a material improvement in operational results. Also, shareholder returns will improve, making it one of the best energy stocks to buy.
On the date of publication, Charles Munyi did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.