Time To Slide Into Oil Stocks

by: Mike Nadel

The last time I filled my car's tank, I paid less than $3 a gallon. As my wife will attest, I was more than a little giddy. "Two-ninety-seven!?!? You gotta be kidding me!!! This is incredible!!!" Hey, we all have to find life's little thrills wherever we can, right?

The price of crude oil, the source of gasoline, is determined by numerous factors: supply and demand, the Middle East unrest, natural and unnatural disasters, Wall Street speculators, economies in the U.S., Europe and emerging markets, etc.

Crude oil reached $110 per barrel on February 24 and was still over $100 per barrel two months later. It has been on a fairly steady decline since, hitting $80 per barrel on June 22 - its lowest level in two years - before rebounding into the mid-80s. So what's next?

I certainly am no oil-price-trend expert... and even if I were, I wouldn't listen to myself. Wasn't it just a few months ago that alleged experts were predicting $5 gas by Memorial Day and maybe even $6 by the Fourth of July? Still, when it comes to forecasting oil prices, "Up" usually is a reasonable guess - especially after it has been down.

There will be no giddiness if and when we're pumping $5 unleaded, but there is one way to cushion the blow a little: own oil (and oil-related) stocks. Prices of those equities almost always operate in lockstep with the price of oil.

The Dividend Growth portfolio I am slowly building owns nary an oil stock, even though some of these companies have been reliable dividend growers for years. I want to change that, and here are the companies I'm considering:

ConocoPhillips (NYSE:COP): Although some lingering questions remain after its May spinoff of Phillips 66 (NYSE:PSX), it's hard not to like the numbers. Those include a 4.7 percent dividend, a P/E ratio of 6.2, a 29 percent payout ratio and a 12-year run of dividend increases. Its beta (1.13) is a little higher than I normally like, but that extra bit of volatility seems priced in. I've got a $53 limit order, which would make its yield almost 5 percent, and I might even decide to buy half my eventual stake at a slightly higher entry point.

Royal Dutch Shell (NYSE:RDS.B): One of the many wonderful things about David Fish's chronicling of Dividend Champions, Contenders and Challengers is that he also lists "Frozen Angels" - companies that had increased dividends for some time, then froze dividends for a couple of years and then went back to raising them. Royal Dutch Shell is in that group, and I definitely take a glass-half-full view because so many companies cut dividends during the recession.

This British-Dutch behemoth has been growing revenue significantly and has become a major natural-gas player. The company's B shares are perfect for DRiP investors because they pay dividends in shares equivalent to a yield of about 5.3 percent. That's slightly higher than the A shares (NYSE:RDS.A) yield, and it lets shareholders avoid the 15 percent Dutch withholding tax. I have a $69 limit order.

Exxon Mobil (NYSE:XOM): This gold standard of oil companies has raised dividends for 30 years running and boosted this year's dividend by 21 percent. Its payout ratio of only 23 percent suggests more nice hikes are in the offing. It's got very little debt and a 10.8 forward P/E. I just wish it yielded more than 2.7 percent, which is lower than any stocks I own. I've got a limit order at $75, which would make it a 3 percent yielder. Such a 13 price pullback could happen, but I'm not holding my breath.

Chevron (NYSE:CVX): Thanks to its 3.4 percent dividend yield, 23 percent payout ratio, 8.3 P/E ratio and 25-year run of hiking dividends, this company is favored by many Seeking Alpha authors I respect. Even with the recent oil-price plunge, however, it's pretty close to its 52-week high ($112). It'll have to fall into the low-90s before I'm a buyer. Again, I might be waiting awhile.

BP p.l.c. (NYSE:BP): Given its 4.7 percent dividend and 5.3 trailing P/E, I really want to love this company. It has been through so much drama, though. Investors are still waiting to hear what the damages will be from the 2010 Gulf of Mexico disaster, there have been other legal actions against BP and the company has negative debt to free-cash flow. On the positive side, its board really seems to be trying to please investors, raising its dividend by 14 percent this year after halving it in the wake of its Gulf catastrophe. This is a wait-and-see deal for me; I'll wait till its price recedes some more and then see if I want to buy it.

Seadrill Limited (NYSE:SDRL): This offshore drilling company would be a relatively high-risk play, and it certainly isn't on David Fish's CCC lists. It has a 155 percent payout ratio, a 1.99 beta and oodles of debt, but it is yielding about 7 percent and the newness of its deep-sea rigs has made it a favorite among major oil companies. If it pulls back to the low-30s, as it did last month, I'd consider a small "fun" investment. Despite its Norwegian heritage, it is "domiciled" in Bermuda, making it tax-friendly for American investors.

I also am considering MLPs, including Kinder Morgan Partners (NYSE:KMP), Enbridge Energy Partners (NYSE:EEP), Magellan Mainstream Partners (NYSE:MMP) and Linn Energy (LINE). Since most of my available money is in IRAs, I likely would buy shares of Kinder Morgan Management (NYSE:KMR) and Enbridge Energy Management (NYSE:EEQ). Those partners to KMP and EEP distribute additional shares rather than cash, thus avoiding potential tax-time headaches; because I mostly DRiP my equities, it would be a nice fit for my portfolio. I would need to free up money in my taxable account to buy MMP and LINE, the latter an especially tempting high-yielder. I'm still researching these and other pipeline companies and trying to determine attractive entry points.

Roughly 40 percent of my portfolio is in cash, putting me in excellent position to be a buyer in the next big pullback. If that includes lower oil prices - and most big pullbacks do - I will get giddy all over again. I'll back up my portfolio to the Dividend Growth investing pump and say: "Fill 'er up!"

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in COP, RDS.B, XOM, BP, SDRL, KMR, MMP, EEQ, LINE over the next 72 hours.