2 Major Oil And Gas Stocks To Buy And Hold, 1 To Just Hold

Includes: COP, CVX, WMB
by: Takeover Analyst

From high dividend yields to strong economic moats, large oil & gas firms are an attractive bet to make on an economic turnaround. Williams Companies (NYSE:WMB), Chevron (NYSE:CVX), and ConocoPhillips (NYSE:COP) are all committed to returning free cash flow to shareholders while still retaining a meaningful amount of earnings for growth opportunities. With the exception of Williams, these energy producers trade at extremely low multiples that are well positioned to expand when fears over a double dip go away. Williams is still rated a "buy" on the Street according to data sourced from FINVIZ.com, but I do not believe its upside potential is as high as it is for Conoco and Chevron.

Williams Companies

After rising steadily in the beginning of this year, shareholder value has started to fall only to recover again. In my view, the stock is fairly expensive at a respective 24.1x and 21.1x past and forward earnings since annual EPS growth of 13.1% is largely uncertain. As it stands, the company has a PEG ratio of 1.84, which indicates that future stock growth has been more than compensated into the stock price.

Second quarter results were below expectations, but management is nevertheless raising guidance for 2014 on the prospects of more attractive petchem pricing. The midpoint of 2014 EPS was pegged at $0.13. To streamline the business and raise cash, management is also intending to sell the Geismer olefins business. Much of the value creation going forward will be dependent on dividend growth being reaffirmed. Management is aiming for 20% dividend growth in 2013 and 2014 - which investors will be chiefly focused on.

Management is currently struggling in midstream with higher costs from maintenance, lower margins, and softer-than-usual volume as a result of construction. Dropping the Geismar business would be a smart move due to FX headwinds and precarious ethane exposure. With the spinoff of WPX Energy behind, Williams can focus more on being a pipeline business. The tight integration of midstream enables the company to capture greater extraordinary profit from the supply chain. The high multiple, however, have limited much of the upside. I thus recommend a "hold".


The combination of respective PE and forward PE multiples of 6x and 9.6x, and a dividend yield of 4.9% makes Conoco a very compelling "buy" from a risk/reward standpoint. The company's bar has also been set overly low, with just 1.3% annual EPS growth forecasted over the next 5 years. This is particularly odd when you consider that the 7.2x larger Exxon Mobil (NYSE:XOM) is forecasted for 7.5% annual EPS growth and trades at 10.5x past earnings. Accordingly, Conoco has a large bar from which to appreciate off of.

It is important to note that the company has beaten expectations for 4 of the last 5 quarters by an average of 8.1%, with the only miss being the less deviant from consensus at -2.9%. During the recent second quarter, EPS of $1.22 was 4.3% better than expected. If the company can just grow EPS by 3%, 2016 EPS will come out to $6.17. At a 12x multiple, the future stock value would be $74.09. When complemented with the 4.9% dividend yield, downside is thus relatively limited.

During the first half of 2012, cash flow was unable to meet capex and dividends - mainly as a result of soft performance in the upstream portfolio. I believe that investors are overly pessimistic about negative free cash flow into the future and have failed to appreciate that management will be reducing capex through divestures and project completions. Net debt may rise by around $15B over the next three years from 2011, but the investments now will pay off later when the company's disadvantaged barrels - WTI-linked crude and natural gas particularly - become more preferred.


Chevron is another attractive major oil & gas firm that, despite its size, still generates double-digit ROA, ROE, and ROI. The Standard Oil heir trades at just a respective 8.1x and 9x past and forward earnings with a dividend yield 3.3%. Over the last 5 years, the company grew EPS by an impressive 11.5% annually. Only 2.1% annual EPS growth is expected over the next 5 years, which, again, sets the bar very low for high returns.

With a lack of debt on the balance sheet, Chevron is also a very a safe investment. The payout ratio is also just 23%, and management consistently raises dividend yields, so the income opportunity is substantial in the long term. While only modest growth is expected in the near-future, the company is positioned well from a competitive standpoint, as 75% of volumes are tied to attractive Brent prices. Earnings per barrel upstream have thus been terrific in 2012. Production ramp up in the LNG projects in 2017 will become increasingly relevant and improve the soft growth story.

Despite an excellent economic moat, commitment to shareholder value, and an excellent competitive position, investors remain singularly focused on litigation in Ecuador and instability in Nigeria and Brazil. The market, moreover, should be cognizant that Chevron is focused on mainly the Pacific Rim, which will be a prime beneficiary of Asian and Latin American importation. I thus strongly encourage buying shares now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.