Warren Buffett is a fan of energy stocks. Here's one more strong buy signal.

By Michael Brush

Energy company insiders are purchasing far more shares than they're selling. Here's what they're buying.

Warren Buffett isn't the only one who likes the energy sector. Alongside Berkshire Hathaway's (BRK.A) (BRK.B) huge purchases of Occidental Petroleum (OXY) shares, insiders at energy companies have been buying large amounts of stock for weeks and selling very little. Vickers Insider Weekly has singled out the energy sector as an insider favorite in four of the past five weeks, as of Sept. 16.

Buffett plus insiders is a powerful signal. Buffett likes Occidental Petroleum's prodigious cash flow and extensive holdings in the U.S. Southwest's Permian Basin, which helps make it a low-cost producer. But why are insiders buying?

In the big picture, it's because energy-stock prices are seriously lagging. But the weakness won't last forever. "Longer term, this is an industry that is going to grow," says Hennessy Energy Transition Investor HNRGX portfolio manager Ben Cook. "There will be supportive commodity prices and good earnings and cash flow in the right companies. That's attractive and the management teams know it. The insiders recognize there is good opportunity."

Here's how out-of-favor the energy sector is:

The S&P 500 Energy Sector Index XX:SP500.10 is down 1.1% in the past year compared to a 31.7% gain for the S&P 500 SPX.The enterprise value of the energy index is 6.8 times next year's estimated Ebitda, below the 10-year average of 7.9 times, Cook points out. Energy stocks have free-cash-flow yields in the 8%-10% range, more than twice that of the average S&P 500 stock, notes Tortoise Energy Infrastructure Total Return Fund TORIX Manager Robert Thummel.The percentage of S&P 500 earnings from energy companies is around 10% but their market-cap weighting is just 5%, notes Penn Capital Chief Investment Officer Eric Green. Normally, they should be closer to parity.

Unjustified discounts

These steep discounts seem odd for a half-dozen reasons, say energy-investing experts.

Energy companies have become much more shareholder-friendly in the past few years, Cook says. They have better capital-spending discipline, which creates strong free cash flow. They are returning much of that cash to shareholders via dividends and buybacks. "The insiders are saying, 'I am willing to take the downside risk because the investment merit of these stocks has improved,'" Cook adds.

Plus, oil (CL00) (BRN00) prices will likely go higher from here. One reason is that the Middle East could be on the brink of a wider war. Yet oil has not budged in response. "The risk of geopolitical disruption is not priced into oil at all," Cook says.

Global interest-rate cuts will help. Besides the Fed, central banks in Europe and Canada have been cutting rates to support growth. "That creates a healthy environment for energy demand," says Cook. "A growing global economy and pursuit of higher quality of living in less-developed countries ultimately mean an increased need for energy." Meanwhile, that capital discipline among U.S. producers keeps supply in check.

Global demand for U.S. energy also will support domestic producers and services companies. Global demand will grow at least in line with world GDP growth of 1.5%-2%, Thummel says. "Fossil fuels are over 80% of the global energy supply, and that will not dramatically change over the next few decades." Meanwhile, global inventories and the U.S. strategic reserve are below historical level.

Artificial intelligence (AI) requires a lot of computing power, which uses a lot of electricity. This demand will favor natural-gas (NG) producers, notes Thummel, since power plants use a lot of NG. Green at Penn Capital points out that the shares of electric power producers such as Vistra (VST), NRG Energy (NRG) and Talen Energy (TLN) have taken off this year. "The vast majority of that power will be from natural gas," Green says. "But you have had no recognition of this in the price of exploration and production stocks and the service companies that provide the drilling rigs."

The U.S. presidential election outcome will be OK for energy, no matter who wins. Democratic administrations are good for energy stocks because they often restrict supply, notes Green. Meanwhile, Donald Trump's "drill baby drill" mantra might be irrelevant. "Trump won't make energy companies drill like crazy because the investor base will not allow that," Green says. Investors like the cash flow, dividends and share buybacks that come from capital spending discipline. "The only way they will drill more is if oil prices go up and their cash flow allows them to invest."

Favored energy stocks to consider

Cook at Hennessy says oil-services giants Schlumberger (SLB), Baker Hughes (BKR) and Halliburton (HAL) all have been disproportionately punished in the current energy-sector weakness. He favors quality energy companies with better balance sheets including Exxon Mobil (XOM), Cheniere Energy (LNG), EOG Resources (EOG), NextEra Energy (NEE) and ConocoPhillips (COP).

Thummel says Chevron (CVX) shares look excessively discounted because of overblown concerns about foreign investment, which he thinks will soon start paying off. He also singles out Diamondback Energy (FANG) in the belief that it could be an acquisition target as the consolidation among Permian Basin producers continues. "Diamondback is one of the last pure-play Permian producers with significant scale," he says.

Energy stocks insiders are buying

Vickers Insider Weekly highlights bullish energy sector insider buying at: PBF Energy (PBF); Texas Pacific Land (TPL); Talos Energy (TALO); Matador Resources (MTDR); Comstock Resources (CRK;) Global Partners (GLP); Hallador Energy (HNRG); HighPeak Energy (HPK); ProFrac Holding (ACDC), and Granite Ridge Resources (GRNT).

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned PBF, TPL, TALO, MTDR, CRK, HPK, ACDC and GRNT. Brush has suggested BRK.B, OXY, SLB, HAL, XOM, LNG, EOG, COP, CVX, PBF, TPL, TALO, MTDR, CRK, HNRG, HPK, ACDC and GRNT in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks.

More: Nvidia's stock is no longer the S&P 500's top gainer this year. Here's what is.

Plus: Tech giants desperate to power AI data centers are turning to nuclear disaster sites - despite the risks

-Michael Brush

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

09-24-24 0725ET

Copyright (c) 2024 Dow Jones & Company, Inc.