14 energy stocks whose ample cash flow might benefit shareholders
By Philip van Doorn
Favored names expected to continue gushing cash include Devon, Halliburton and Schlumberger
The past year has been very good for the broad U.S. stock market, but there are always sectors that lag behind. The energy sector has been the worst performer among the 11 sectors of the S&P 500. And at a time of continual warnings that stock valuations are getting stretched, a comparison of sectors' price-to-earnings valuations underscores what may be an excellent entry point for investors.
On Thursday, Ned Davis Research analysts Rob Anderson and Thanh Nguyen wrote in a note to clients that energy was "the most oversold sector relative to the S&P 500 on both a six- and 12-month basis," based on trading patterns.
They also pointed to two possible catalysts for oil: "Israel's pivot from Hamas to Hezbollah has increased the possibility of a broader Middle East conflict and could lead to a higher geopolitical risk premium for crude. At the same time, China's 'stimulus blitz' has the potential to positively impact the demand side of the equation."
They added: "Crude money market short positions have reversed from an extreme high, providing a buy signal for oil."
We cannot predict how oil prices will move, but over the past few years, U.S. oil producers have benefitted from steady cash flow while keeping the lid on capital spending. Much of the companies' free cash flow has been allocated for dividends and share buybacks. Lower share counts mean higher earnings per share, which can support higher stock prices over the long term. So this is a good time to look at companies' free cash flow yields and list those that might continue to take actions considered friendly to shareholders.
Read: Warren Buffett is a fan of energy stocks. Here's one more strong buy signal.
A stark valuation difference for energy stocks
This chart shows forward P/E ratios for the 11 sectors of the S&P 500 SPX as of Friday's close, based on consensus estimates among analysts polled by FactSet, weighted by market capitalization. The sectors are by P/E ascending, with the full index at the bottom of the table.
Sector or index Forward P/E Forward P/E one year ago 1-year P/E increase Current P/E to 10-year average 1-year price change Energy 12.6 12.1 0.5 82% -5.2% Financials 15.9 13.0 2.9 111% 35.9% Utilities 18.9 15.1 3.7 108% 33.8% Communication Services 18.9 16.3 2.7 100% 41.1% Real Estate 19.3 15.0 4.3 102% 31.7% Healthcare 19.5 17.1 2.4 118% 18.6% Materials 20.9 16.8 4.1 124% 24.6% Consumer Staples 22.0 18.6 3.3 112% 21.9% Industrials 22.5 17.9 4.6 118% 32.9% Consumer Discretionary 26.4 24.0 2.4 100% 29.3% Information Technology 28.86 23.96 4.9 145% 52.3% S&P 500 21.6 18.0 3.6 118% 34.2% Source: FactSet
-- Forward P/E ratios for all sectors and the full S&P 500 have risen from a year ago, but the energy sector has shown the smallest increase and remains cheapest by this measure.
-- The full S&P 500 trades at a forward P/E of 21.6, up from 18 a year ago. The index's forward P/E is 118% of its 10-year average.
-- The energy sector is the only one of the 11 sectors of the S&P 500 whose forward P/E is below its 10-year average.
A free-cash-flow screen
There are only 22 stocks in the S&P 500 energy sector. An easy way to play the sector is by purchasing shares of the Energy Select SPDR ETF XLE, which holds all 22 stocks weighted by market cap. This means that Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) together make up 41.5% of the portfolio.
To avoid that type of concentration, the Invesco S&P 500 Equal Weight Energy ETF RSPG holds the same stocks but they are rebalanced quarterly for equal allocation. Through Friday, RSPG's five-year total return with dividends reinvested was 99.1%, compared with an 88.2% return for XLE. These returns are net of expenses, which come to 0.09% of average assets under management annually for XLE and 0.40% for RSPG.
For an expanded list of energy stocks to screen, we began with the 72 stocks in the S&P Composite 1500 Index XX:SP1500, which is made up of the S&P 500, the S&P MidCap 400 MID and the S&P Small Cap 600 Index SML.
Free cash flow is a company's remaining cash flow after capital expenditures. It is money that is available to pay dividends, buy back shares, make acquisitions, expand organically or for other corporate purposes.
If we divide a company's tailing or estimated free cash flow per share by its share price, we have a free-cash-flow yield that can be compared with its current dividend yield to show how much "headroom" there is for a company to allocate excess cash.
We began by narrowing our list of 72 stocks to 66 covered by at least five analysts polled by FactSet. Trailing FCF yields were based on the past four reported quarters. For forward FCF yields, we used consensus estimates for the next full fiscal year, since these were more readily available than estimates for the next 12-month estimates. The annual estimates were available for 44 companies.
Among the 44 remaining companies, 14 had trailing and forward FCF headroom of at least 4%, while also being rated a buy or the equivalent by the majority of analysts polled by FactSet. Here they are, sorted by estimated forward FCF headroom:
Ovintiv Inc. Ticker Dividend yield Forward FCF Yield Estimated forward FCF headroom Trailing FCF yield Trailing FCF headroom Marathon Petroleum Corp. MPC 2.02% 14.26% 12.25% 15.41% 13.39% Ovintiv Inc. OVV 3.13% 14.49% 11.36% 11.87% 8.75% Permian Resources Corp. PR 1.78% 12.36% 10.58% 7.22% 5.44% SM Energy Co. SM 2.01% 12.29% 10.28% 10.78% 8.77% Chord Energy Corp. CHRD 3.82% 13.56% 9.74% 11.85% 8.03% Diamondback Energy Inc. FANG 2.11% 9.84% 7.73% 10.73% 8.62% NOV Inc. NOV 1.56%8.76% 7.20% 7.41% 5.84% Liberty Energy Inc. Class A LBRT 1.48% 8.64% 7.17% 11.98% 10.51% Devon Energy Corp. DVN 4.57% 11.73% 7.16% 12.32% 7.75% Valero Energy Corp. VLO 3.15% 9.69% 6.54% 18.15% 15.00% Halliburton Co. HAL 2.37% 8.38% 6.00% 9.32% 6.95% Peabody Energy Corp. BTU 1.15% 6.45% 5.29% 19.65% 18.50% Schlumberger Ltd. SLB 2.60% 6.76% 4.16% 7.44% 4.84% ConocoPhillips COP 2.22% 6.31% 4.10% 7.59% 5.37% Source: FactSet
Leaving the list in the same order, here is a summary of ratings among analysts polled by FactSet:
Ovintiv Inc. Ticker Share "buy' ratings Sept. 27 price Consensus price target Implied 12-month upside potential Forward P/E Marathon Petroleum Corp. MPC 58% $163.65 $181.56 11% 13.6 Ovintiv Inc OVV 67% $38.37 $57.13 49% 7.1 Permian Resources Corp. PR 91% $13.51 $19.20 42% 8.8 SM Energy Co. SM 59% $39.81 $55.00 38% 4.8 Chord Energy Corp. CHRD 82% $130.80 $191.36 46% 7.3
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