The Strongest Stress-Tested Energy Stocks

|
Includes: CVX, NOV
by: Brad Kenagy

Summary

After the recent decline in crude oil price, I screened for energy stocks.

I put an emphasis on screening for larger companies that had a low debt/capital ratio, the ability to pay off any short-term expenses, and a low dividend payout ratio.

I valued each of the companies on my final list using stressed metrics to accommodate the fast and steep decline in oil prices.

In this article, I will be looking for energy stocks that have value after the recent sell-off in crude oil. Because of OPEC's decision last week not to cut production, oil stocks, MLPs, refiners, railroads, rail car manufacturers, and pretty much anything else oil-related saw large declines on Friday.

I will be screening for the strongest energy stocks, and valuing those companies with more stringent assumptions because of the 25.11% decline in crude oil this quarter. For my search, I used the Zacks stock screener with the criteria below. I chose to include companies with a $5 billion or greater market cap, because small-cap energy stocks are the most vulnerable if oil continues to decline. In addition, I added criteria like low debt-to-capital and current ratios, to assess the ability to pay current and future debts.

Criteria

  • Sector: Oils-Energy
  • Exchange: Not OTC
  • Market Cap: >5000 [$5 billion]
  • Dividend: >.01
  • TTM EPS: >.01
  • Long-Term Growth Estimate: >5
  • Debt/Total Capital: <20
  • Current Ratio: >1

After entering the above criteria, I found that eight companies passed my initial screen. I went a step further to eliminate companies that had a dividend payout ratio of greater than 40%, because I wanted to make sure my final list would not include any companies that could potentially cut their dividend. This test resulted in two of the eight companies being eliminated leaving my final list consisting of the following stocks.

Dividend Payout Ratio

Debt/Capital

HELMERICH & PAYNE Inc

HP

38.39%

0.81

OCCIDENTAL PETROLEUM CORPORATION

OXY

37.43%

13.43

CHEVRON CORPORATION

CVX

35.91%

11.30

BAKER HUGHES Inc

BHI

17.65%

17.56

NATIONAL OILWELL VARCO Inc

NOV

14.38%

12.17

HESS CORPORATION

HES

14.11%

19.57

Valuation Stress Test

For each of the six stocks above, I conducted a fair value estimate as I normally would. However, in this case, because of the size and speed of the deterioration in oil prices, I put each company through tougher scrutiny. I used the 25.11% in oil and applied that percentage decline to the estimated long-term EPS growth for each company. In addition, I increased the discount rate for each stock by the same 25.11% to reflect the increased uncertainty of future oil prices. I used a DCF calculator with EPS, and growth data for each company from Zacks, and a risk-adjusted discount rate for each company with beta data from NASDAQ.

DCF Calculator Assumptions

  • Earnings grow for next: 5 years
  • Level off to 1%

Discount Rate Calculator Inputs

  • S&P 500 Annualized return: 7.90%
  • Return on risk-free investment [10-year yield]: 2.18%

Valuation Results

For the inputs of the DCF calculator, I used the TTM EPS, adjusted LT Growth Estimate, and the adjusted discount rate. The following table shows that using EPS growth that is adjusted downward by 25.11%, and a discount rate that is adjusted 25.11% higher, only Chevron, and National Oilwell Varco I determined were undervalued at current prices.

EPS[ttm]

LT Growth Est.

Adjusted LT Growth Est

Discount Rate

Adjusted Discount

Est Value

Current Value

HP

6.35

12.5

9.36

12.48

15.61

$60.20

$67.79

Overvalued

OXY

6.84

5.28

3.95

9.9

12.39

$68.28

$76.55

Overvalued

CVX

10.86

6.3

4.72

8.41

10.52

$134.32

$110.66

Undervalued

BHI

3.4

10

7.49

11.27

14.10

$33.71

$56.08

Overvalued

NOV

6.33

9.37

7.02

9.22

11.53

$77.40

$65.38

Undervalued

HES

4.96

9.83

7.36

10.53

13.17

$52.86

$71.74

Overvalued

Observations & Closing Thoughts

I looked at the dividend history of CVX, and NOV and saw that Chevron has increased its dividend steadily, and has never decreased its dividend in the last 20 years, even when oil was somewhere in the range of below $20 to over $140. This can give investors a vote of confidence that pretty much no matter the price of crude oil, CVX will be able to increased and/or maintain its dividend.

NOV started paying a dividend in 2009, and has increased its dividend every year since then. Because NOV started paying a dividend in late 2009 when oil prices were in the $70 range, there is somewhat of an unknown as to if, NOV will continue raising its dividend every year as they have done in the past. I would expect NOV would continue to raise the dividend because of its low dividend payout ratio; however, I think the increase would be much smaller than the last couple of years in which NOV doubled its quarterly dividend.

In closing, I believe CVX and NOV are worth a deeper look because I believe the 5% + sell-off last week in each stock, and the potential for further declines in crude oil, are an opportunity to purchase shares that are undervalued based on my stressed valuation test.

Disclaimer: Click here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.