Yahoo Finance Is Now a Good Time to Invest in Energy Stocks?
Earlier this year, crude oil prices plunged to a low of $26 per barrel and natural gas prices faced significant pressure. At the bottom, oil traded at a 65 percent discount to its five-year moving average. While the price per barrel has recently climbed to about $50, many exploration and production companies failed, or were on the brink of failure, over the past year as borrowing rates surged and the ability to service debt was in peril.
With prices still down by more than half since the price collapse two and a half years ago, which required much needed fiscal restraint as well as restructuring of outstanding debt, companies now have the breathing room they need to start investing for growth.
The outcome of OPEC's most recent meeting on Nov. 30 resulted in an agreed six-month production cut of 1.2 million barrels of oil a day -- from an official production level of 33.6 million barrels a day beginning in January. Non-OPEC countries also agreed to cut by an additional 600,000 barrels. Given the dubious nature of compliance to past agreements, only time will tell if the agreed upon cuts will hold. However, given the intentions for a cut and assuming a 75 percent compliance rate, this should be enough to keep the price of oil in mid-to-high $50-per-barrel range.
[See: Oil ETFs: 8 Ways to Invest in Black Gold.]
This year will mark the bottom for the energy cycle and investment opportunities will continue into 2018. Here are two stocks that may have further room to advance.
Valero Energy Corp. (ticker: VLO). Valero is the largest stand-alone oil refining company in the world with refining capacity of 3 million barrels per day. Fifty-five percent of the company's refineries are located along the Gulf Coast, and these refineries have the flexibility to refine a wide variety of imported and domestic crudes and export them to the growing economies of Latin America, eastern Canada and northern Europe. Valero's cash operating costs per barrel are 20 percent lower than its median competitor and 33 percent lower than its highest cost competitor.
Valero has used its incremental free cash flow to improve the reliability and safety profile of its operation and to grow its dividend. The company's dividend yield of 3.81 percent is projected to grow 9 percent per year for the next three years. Valero is trading 13 times forward 12 months' earnings, which is in line with its historical valuation and reasonable for a company that is expected to grow earnings 4 to 5 percent per year over the long term.
[See: 7 of the Best Stocks to Buy for 2017.]
However, the earnings growth rate may be closer to 9 to 10 percent for the next two to three years. The company is spending $750 million to $850 million per year to comply with renewable identification number prices. Should the new administration reduce the cost and complexity of compliance, this move could boost earnings per share by up to $1 per share by 2018. Additionally, the company has a $2.7 billion authorization from the board to repurchase shares, which could further boost EPS by up to 10 percent by the end of 2018.
Baker Hughes (BHI). In October, Baker Hughes and General Electric Co.'s ( GE) oil and gas division announced that they would be merging, with GE owning 62.5 percent of the combined company and existing Baker Hughes shareholders owning the rest. Baker Hughes shareholders are also entitled to a special $17.50 special dividend.
Baker Hughes brings strong customer relationships and energy services expertise, while General Electric brings leading edge manufacturing technology that leverages the strong R&D capabilities. General Electric has used this centralized R&D center to dramatically reduce costs at previous acquisitions it has made at General Electric oil and gas. For example, it can use expertise in coatings and 3-D printing to redesign existing machinery used by BHI to reduce costs and improve the uptime for clients. Furthermore, General Electric brings expertise in imaging and data analytics, which it can sell to Baker Hughes customers as incremental services.
The combined company estimates they will be able to reduce costs by $1.2 billion and increase incremental revenues by $400 million by year end 2020, assuming oil prices stay within $45 and $60 per barrel. Revenues are projected at $34 billion for 2020, which would represent less than 5 percent market share of the spending that global oil and gas companies spend annually on equipment and services.
This figure is conservative and it's estimated that the new company will overtake the current No. 1 player, Schlumberger ( SLB), by 2020 due to General Electric's advanced technologies, which are critical for companies that are drilling increasingly complex and deeper wells. Assuming the new company generates $6 per share in 2020 (a return to its previous peak in 2007) and a 10 times multiple, the share would be worth $60 per share. Shareholders are entitled to a $17.50 per share dividend. It's estimated that the company's share would be worth $77.50 per share by the end of 2019.
[See: 7 Notable Quotes From Warren Buffett.]
As noted, there will be investment opportunities in the energy space over the next year. Valero and Baker Hughes are two examples of companies that have growth prospects, which investors should keep an eye on.
Disclosure: Leslie Thompson and clients of Spectrum Management Group own VLO.
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