Some Energy Stocks Have Power
The S&P 1500 Energy Sector Index has lived up to its name over the last decade, powering past the other nine sectors of the index with an annualized total return of 12.7%. But just looking at the decade by itself obscures the most interesting aspect of the story.
In the last five years, the energy sector returned an annualized 17.2%, third-lowest among sectors during a period when the broader index returned an annualized 23.5%. But in the previous five years, a period ended February 2009, the energy sector returned an annualized 8.4%, one of only three sectors to post a positive return and by far the strongest of those.
You might be tempted, looking at energy's 10-year returns, to simply label the group pricey and stay away. But S&P 1500 energy stocks average Quadrix Value scores of 67, among the highest of any sector. The sector averages Overall scores of 59, in line with the index average.
Energy's returns are highly correlated with oil prices; they tend to rise when oil prices rise, and vice versa. West Texas Intermediate per-barrel oil prices have nearly tripled over the last decade. However, they haven't done much over the last three years, and neither have energy stocks.
The sector is coming off a particularly weak quarter. Only 55% of S&P 500 Index energy stocks topped fourth-quarter profit expectations, well below the 65% for all index stocks. The sector's per-share profits probably fell more than 8% from the year-earlier quarter, by far the worst of any sector. Hurt by unimpressive results and disappointing guidance, profit-growth expectations for the sector have fallen sharply since the start of the year.
However, we have a cautiously positive outlook for energy stocks, particularly those leveraged to U.S. production. According to the U.S. Energy Information Administration, monthly oil production in this country averaged 235 million barrels in the three months ended November, up 69% from five years ago and the strongest since 1989.
At the moment we favor energy-services companies and independent producers with demonstrably superior production-growth potential. Bucking the industry trend, most of our recommended energy stocks are expected to post solid profit growth in the year ahead.
Helmerich & Payne's ($99; HP) fleet of drilling rigs enjoys a technological advantage over many of its peers, allowing the company to steadily expand its return on equity and operating profit margins, both up in three consecutive years. With rig utilization in the U.S. land market on the rise, management anticipates modestly higher demand and prices in 2014.
After delivering a 58% total return over the last year, H&P trades at 17 times trailing earnings, a 7% premium to the median for S&P 1500 oil-and-gas drillers. However, the stock yields 2.5% and looks attractively priced relative to estimated annual profit growth of 14% over the next five years. H&P is a Focus List Buy and a Long-Term Buy.
Schlumberger's ($92; SLB) earnings per share rose 26% and cash from operations 46% in 2013 on sales growth of 7%. Free cash flow totaled $3.84 billion, compared to just $210 million in 2012, paving the way for a 28% dividend increase announced in January — its biggest hike since 2007.
Management expects improvement in the U.S. and Europe to accelerate global growth in oil demand. Schlumberger had counted on Russia to contribute, but operations there could be disrupted if the U.S. or Europe impose economic sanctions in retaliation for Russia's invasion of Ukraine. The consensus expects per-share profits to jump 21% to $5.73 this year. Shares trade at 16 times estimated 2014 earnings, a 7% discount to the median for S&P 1500 oil-and-gas equipment and services stocks. Schlumberger, yielding 1.7%, is a Focus List Buy and a Long-Term Buy.
Whiting Petroleum ($71; WLL) CEO James Volker predicts the Bakken shale formation will become a large source — possibly the primary source — of oil for the Midwest and Northeast regions within a year. The Williston Basin, an area that contains the Bakken, accounts for nearly 75% of Whiting's production. At current production levels, Whiting estimates it has 22 years of drilling inventory in the Williston Basin.
Despite weather-related delays, Whiting said in late February that production should rise 11% to 13% in the March quarter and 17% to 19% in 2014. That production guidance exceeded analyst expectations and could cause 2014 profit estimates to drift higher in coming weeks. For now, the consensus projects 3% lower earnings per share this year, attributable in part to last year's $860 million sale of oil-producing assets in Oklahoma. Whiting Petroleum is a Focus List Buy and a Long-Term Buy.
Shares of Chevron ($115; CVX) and Exxon Mobil ($97; XOM) are each down at least 4% so far in 2014, as the energy giants find it increasingly expensive to tread water. Both companies posted lower profits and sales for the December quarter as production continued to decline. They spent a combined $71.65 billion on exploration and other capital projects last year, up 10%. For all that spending, production expectations are rather dim — Chevron targets 0.5% higher production in 2014, while Exxon hopes for 2% to 3% growth by 2017.
Although both stocks offer solid yields, investors would do better to look elsewhere. Chevron and Exxon Mobil are rated C (below average).