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The energy sector was the weakest sector in the S&P500 in 2017, losing 5.1 percent.
However, the sector ended the year 13 percent higher than the lowest levels it reached in August.
The oil price is a function of supply and demand, and for much of the last decade supply has grown faster than demand. However, the lower oil price put the brakes on new supply, and better than expected global growth has caused demand to accelerate.
By the third quarter of 2017 inventories, particularly in the US, began to drop – a sure sign that the supply-demand balance is shifting.
Oil production takes time to adjust to changes in demand which causes the oil price to move in persistent trends. Unless we have any unforeseen shocks over the next year, there is a better than average chance the oil price will continue to move higher (and we’ve already discussed the on the different ways to invest in oil besides energy stocks exposure).
Best Energy Stocks For Investment
The following are four oil stocks to consider investing in for the remainder of 2018.
Chevron (NYSE: CVX)
Market Cap: $243 Billion | PE: 37 | Forward PE: 21 | Div Yield: 3.36%
ExxonMobil and Chevron are the two large US energy stocks. These are the safest companies in the sector as they are well diversified and vertically integrated. They are involved in exploration, extraction, refining, and marketing. Investors should own one of these two stocks, if not both.
Despite Chevron outperforming Exxon in 2017, the forward PEs remain about the same. On a longer-term view, Exxon might be the better pick as it has a higher return on equity, dividend yield and it’s slightly cheaper.
However, given the strong fundamentals for the energy business, there are several reasons to believe Chevron may continue to outperform through 2018.
Firstly, Chevron’s year-on-year increases in production are outpacing those of Exxon. The oil price was under pressure from mid-2014 until mid-2017, and Chevron was forced to cut costs and sell underperforming assets. It is now a far more streamlined and profitable business.
From a technical perspective, Chevron has developed a strong trend, but given the longer-term picture, it’s not yet overbought.
While smaller stocks may outperform, for large institutional investors, Chevron is the go-to large-cap energy stock. If the oil price remains steady or continues to move higher, large investors are likely to continue accumulating the stock, thereby keeping the momentum going.
BP Plc (NYSE ADR: BP)
Market Cap: $144 Billion | PE: 37 | Forward PE: 16 | Div Yield: 5.54%
British energy giant BP Plc is one of the cheapest among the global oil producers. The company has had a tough time over the last decade. The Deepwater Horizon disaster and oil spill cost the company over $8 billion and has weighed on the company’s profitability ever since.
However, the financial strain forced the company to restructure and rationalize its business. In addition, most of the payments related to Deepwater Horizon have now been made.
BP’s fortunes are now turning around. In 2017, third-quarter earnings were almost double those of the previous year, and the profitability of its downstream business was the highest for five years. Analysts are now forecasting earnings growth in 2018 to be 46 percent.
Amongst the large global energy stocks, investors have preferred Exxon and Shell over BP over the last decade. Large investment funds have longer time horizons and look beyond the immediate oil price. For several reasons, these funds may begin to now pick BP over its peers.
Great Margin, Higher Earnings
Firstly, BP’s profit margin is lower than Shell (which is also recommended as high dividend stock) or Exxon, but it has more room for improvement. That will allow the company to grow its earnings faster than its peers. Secondly, the dividend yield at 5.5 percent is far higher than any other large oil producer. And finally, BP earns a higher percentage of its earnings from downstream activities than its competitors. That means it will be more resilient to volatility in the oil price in the longer term.
The stock price recently broke bearish resistance dating back to 2007, which may set up a strong move in the coming years.
Schlumberger Limited (NYSE: SLB)
Market Cap: $105 Billion | PE: – | Forward PE: 24 | Div Yield: 2.62%
Schlumberger supplies technology and services to oil and gas companies around the world. While many marginal oil producers struggle to break even with oil prices below $45, with an oil price above $50, they are more inclined to expand their operations. Schlumberger is ideally placed to benefit as the exploration and drilling industry expands.
Schlumberger struggled when the industry contracted between 2014 and 2017, and the share price declined as much as 50 percent. However, earnings grew 21 percent between January and September 2017 and analysts are forecasting 43 percent earnings growth in 2018.
The company has grown its market share as a service provider to the hydraulic fracturing and drilling services, which should lead to a sustained recovery provided oil prices don’t retreat. Furthermore, Schlumberger is diversified internationally which will cushion the effect of volatility in the US market.
From a technical perspective, the stock has encountered overhead resistance which has led to consolidation in the stock price.
However, given the strong fundamentals, that resistance should give way, and that would lead to another strong rally.
Diamondback Energy Inc. (NASDAQ: FANG)
Market Cap: $12.7 Billion | PE: 31 | Forward PE: 18 | Div Yield: 0%
Diamondback Energy is the smallest and riskiest of these four picks. However, it is widely regarded as one of the best pure play oil stocks in the US. Diamondback is an independent oil producer that only operates in the Permian Basin in West Texas. As an upstream producer, it is highly geared to the oil price.
The company is very well managed and remained profitable when the oil price fell below $45 and many competitors were losing money. While other producers were scaling back their operations and selling assets, Diamondback bought new drilling locations and expanded its production.
It currently has 4,500 locations where it can drill profitably while the oil price is above $60. That means its profits will grow rapidly as the oil price rises from $60 to $80 or even $100. It’s expected to grow its production by 40 percent in 2018, while simultaneously growing margins. The company also has strong free cashflows which will make it more resilient than other independent producers if volatility returns to the oil price.
The stock has been upgraded by analysts at ROTH Capital, Credit Suisse and CitiGroup in recent months. Like many other energy stocks, Diamondback is overbought in the short term. However, provided the oil price remains above $60, the stock price should resume its trend in the coming months.