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Excerpted from June issue of The Turnaround Letter. George Putnam is editor the Turnaround Letter and founder of New Generation Research.
It has become more of a challenge to find stocks trading at attractive valuations. One group that recently caught my eye is the major integrated oil companies.
Most of the stocks in this group have underperformed the S&P 500 Index over the past year, many by a significant margin.
Moreover, several of the stocks discussed below have actually declined in 2013 while the S&P has gained about 16 per cent. In addition to trading at more reasonable valuations than much of the market today, most of these stocks have the added benefit of paying relatively high dividends. Therefore, you get well paid from the dividends even if the stock prices continue to languish for a while longer.
Although they may be market laggards at the moment, I like the long-term prospects for the big oil companies. Demand for oil (and natural gas, which many of them produce in addition to oil) is likely to keep rising for the foreseeable future, particularly in the developing countries. And whether oil prices go up or down, the major oil companies always seem to find a way to grind out substantial profits.
Finally, the very fact that the oils often do move independently of the stock market as a whole makes them attractive investments. An oil stock or two can be a useful "anchor to windward" when a bear market eventually rolls around.
The stocks discussed below are all large international oil producers. They all trade at attractive valuations and pay generous dividends.
BP (British Petroleum) is in the middle of a major restructuring that was initially triggered by the disaster at its Deepwater Horizon rig in the Gulf of Mexico. The company has been shedding substantial assets, ranging from the Gulf of Mexico to Russia. In spite of large settlements relating to the Gulf disaster, management has maintained a strong balance sheet. After a brief hiatus, it reinstated the dividend in 2011 and recently raised it. BP's strategy is to develop higher-margin assets; recent successes include a major offshore gas discovery in India and a winning bid for offshore Brazilian properties. BP has a dividend yield of 5 per cent and a forward P/E of 7.6.
Chevron is the fourth largest oil company in the world, based on reserves. Chevron's production visibility is reasonably good, and so we expect cash flow to remain strong. The balance sheet is outstanding with no net debt (cash comfortably exceeding debt). Despite trading near a 52-week high, the stock's valuation remains compelling. It sports a dividend yield of 3.2 per cent and a forward P/E of 10.0.
ConocoPhillips has streamlined its business through a number of asset sales over the last decade. Now the company is more of a pure-play exploration company than most of the other majors. The asset sales have allowed Conoco to strengthen the balance sheet, including the pay-down of some $6-billion in debt. This gives management the flexibility to pursue an active capital investment program while also providing value to shareholders via dividends and share repurchases. COP has a dividend yield of 4.2 per cent and a forward P/E of 10.5.
Exxon Mobil, formed via the 1999 merger between Exxon and Mobil, is the world's largest independent energy company. Its activities are well diversified with oil & gas exploration/production accounting for 64 per cent of 2012 revenues, refining/marketing 28 per cent and chemicals 8 per cent. Exxon is currently the largest producer of natural gas in the U.S., and the bulk of its $38-billion annual capital spending budget is focused on further building its reserves. The balance sheet is strong, cash flow substantial and management is well regarded. XOM has a dividend yield of 5 per cent and a forward P/E of 7.6.
Petrobras is a Brazilian-based, partially state-owned energy company that was riding high a few years ago because of one of the largest offshore oil finds in years. But since 2007, management hasn't been sufficiently attentive to developing new assets, and the stock has suffered. A new president took the helm in early 2012. Many investors remain cautious on the stock, but at current valuations Petrobras offers an intriguing international diversification opportunity. It has a forward P/E of 4.5 and a dividend yield of 3.2 per cent.
Royal Dutch Shell dates back to 1892, but it was the 2005 merger between Royal Dutch Petroleum and Shell Transport and Trading that positioned the company as the world's second-largest diversified energy company. Royal Dutch is a leading producer of liquefied natural gas (LNG) and is recognized as a technology leader. This strength has turned out to be a short-term negative as LNG pricing has been depressed and costs in some regions are rising. But management is focusing on the long-term by divesting non-core assets and developing long-lived assets. RDS has a dividend yield of 4.7 per cent and a forward P/E of 8.1.
Statoil is a large multinational energy company that is majority-owned by the Norwegian government. The company is encouraging the government to loosen drilling restrictions to support long-term growth. In the meantime, Statoil is expanding operations in other parts of the globe, including recently winning 15 new leases in the Gulf of Mexico. While short-term results may be undistinguished, STO appears to be well positioned for long-term growth in both oil and natural gas. Statoil has a dividend yield of 3.8 per cent and a forward P/E of 8.2.
Total is a major, Paris-based integrated energy company with a presence in all facets of the industry. The product mix is about 60 per cent oil and 40 per cent gas. Management has stepped up its acquisition of reserves over the past two years, including drilling in deep Brazilian and Gulf of Mexico waters. However, it may take a couple of years to reap the financial benefits of the stepped up activity. Nonetheless, free cash flow remains positive, and the dividend appears secure. TOT has a dividend yield of 5.4 per cent and a forward P/E of 7.7.