These 3 Top Stocks Could Be Poised For A Correction As Oil Continues To Drop

Includes: COP, CVX, XOM
by: Hawkinvest

The price of oil initially spiked after Bernanke announced the latest QE3 program. Investors see additional action by the Fed as another round of easy money, and since hard assets like gold and oil can't be printed like paper currencies, the first reaction was to buy oil. There is no doubt that tensions in the Middle East, (particularly with Iran) have put support under the price of oil as well. However, in the past three weeks, the price of oil has dropped by about 9%, as the recent boost from QE3 and Iran began to fade. At the end of the day, oil is mostly a supply and demand situation and based on that, it seems like the slide in oil is poised to continue.

In a recent CNBC article, one energy expert, Strategic Energy Advisors Chairman Tom Petrie, suggested that oil is heading lower, especially as we head out of the summer driving season. The article states: "On the crude side, we're amply supplied. It probably gets bigger next year," he said. "We've had a big insecurity premium in the price of oil for most of the year of $15 to $20. That gets eroded in the next three to six months." Prices, Petrie said, could drop to near $70 per barrel. "I think we test into the 80s, low 80s and into the 70s before it's over."

Even though oil has seen a substantial drop in the past three weeks, some of the big oil stocks have rallied with the stock market, and now trade at or near 52-week highs. These high valuations are not likely to last, especially if the price of oil continues to drop to the low $80- or $70-range based on excess supply. Oil production in the United States is now at a 15-year high, and additional supply is poised to come on the market in 2013. Furthermore, recent economic data shows that the United States could be heading for a recession, especially with a looming fiscal cliff. Additionally, the Chicago Purchasing Managers Index dropped below 50 in September -- its lowest level in about three years.

The oil market appears over-supplied now, and with major signs that the economy could be headed for a downturn, it's not likely that the big oil stocks can continue to trade around 52-week highs for much longer. Here are a few stocks that investors should consider cashing out of now while prices are high, and then consider buying back when the share price corrects along with the price of oil:

Exxon Mobil (NYSE:XOM) shares recently hit new 52-week highs, and the stock has not seen a significant pullback from those levels. Exxon stock was trading in the high $70 range in June, and it has been trending higher ever since. The lofty share price has pushed the dividend yield down to just 2.5%, which makes the stock less attractive to income investors. Another factor to consider is that with the stock trading at higher levels, it is more susceptible to a decline if the company reports disappointing earnings or guidance. Exxon actually did disappoint many investors when it announced earnings last quarter, and it could be poised to do so again. This company is the largest producer of natural gas, and heavy exposure to this low-priced energy source has kept a lid on profits and growth. Last quarter, Exxon benefited from a gain related to the sale of a stake in a refining and chemicals business. However, without those one-time gains, the company earned $8.4 billion, or $1.80 per share, while analysts' average forecast was $1.95 per share. An earnings miss or weak guidance while the stock is trading near 52-week highs could cause a large drop in Exxon shares.

Here are some key points for XOM:
Current share price: $92.55
The 52-week range is $73.90 to $93
Earnings estimates for 2012: $7.65 per share
Earnings estimates for 2013: $8.11 per share
Annual dividend: about $2.28 per share, which yields about 2.5%

Chevron Corporation (NYSE:CVX) shares have also been surging to new 52-week highs. The stock was trading below $100 per share in June, but it has seen a steady rise to 52-week highs at about $118 per share. While Chevron may not have as much exposure to natural gas as Exxon does, it is facing other challenges and issues. On August 6, a fire at its Richmond, CA refinery reduced production substantially, and this event has caused gas prices to surge in California to about $5 per gallon. Chevron is also facing legal expenses and lawsuits due to an oil spill that occurred off the coast of Brazil, and the damages are reported at about $22 billion. After a solid run, Chevron shares appear ripe for a pullback, especially if oil prices continue to drop. Lower oil prices have a significant impact on profit margins for major oil companies like Chevron, and it's just not reasonable for investors to keep buying Chevron shares near 52-week highs when oil has already plunged about 9% in three weeks, and prices could be headed even lower.

Here are some key points for CVX:
Current share price: $117.50
The 52-week range is $92.29 to $118.53
Earnings estimates for 2012: $12.87 per share
Earnings estimates for 2013: $12.52 per share
Annual dividend: $3.60 per share, which yields 3.1%

ConocoPhillips (NYSE:COP) is a favorite for many income investors because with a 4.6% yield, it offers one of the highest dividends in the oil sector. This company spun off its refining division, which is now called Phillips 66 (NYSE:PSX). That leaves ConocoPhillips as a more of pure play on natural gas and oil. Since it is a very popular stock for dividend investors, it could be more significantly impacted in the coming months by increased tax rates on dividends. Tax rates on dividends are poised to rise significantly under Obama's 2013 budget. Tax rates are now just 15%, but could jump as high as 44.8%. It's possible that investor demand for dividend income will be sharply curtailed if a huge jump in the tax rate greatly diminishes net returns. For example, with a 4.6% yield now, investors currently net about 3.9% after paying a 15% tax rate. However, an investor who has to pay a 44.8% tax rate will only net about 2.5%, and that makes dividend plays like ConocoPhillips much less attractive, especially when you consider the risks of owning stocks. For many investors, it might make more sense to buy corporate bonds that yield about the same, and offer what might be a lot less risk. This issue could spark a sell-off in many popular dividend stocks as 2013 draws near.

Here are some key points for COP:
Current share price: $57.58
The 52-week range is $50.62 to $78.29
Earnings estimates for 2012: $5.62 per share
Earnings estimates for 2013: $5.68 per share
Annual dividend: $2.64 per share, which yields 4.6%

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for
informational purposes only. You should always consult a financial advisor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.