Seeking Alpha

My Case For Going Long Oil Stocks

|
Includes: CVX, EGY, FSENX, IEO, MPC, MRO, OXY, PED, PSX, REI, XLE, XOM
by: David Kugelman
David Kugelman
Micro-cap, special situations, long/short equity, Growth
Summary

Articles about oil stocks and oil prices are mostly bearish. If you are a bit of a contrarian, it might be time to start looking for stocks that are oversold.

Oil, just like everything else, trades in cycles. Oil prices are not crashing, oil prices are simply in the middle of a cycle.

The Exploration & Production (E&P) companies get hit the hardest when oil prices drop, since they are in the high-risk/high-reward area of finding, producing, and merchandising oil and gas.

There are a slew of E&P companies, but it is impossible to list them all here. I am including three companies I consider to be well managed. All three trade below book value per share, with positive earnings and plenty of cash.

For those who might not be familiar with the industry, I am also including one no-load closed end fund and two exchange-traded funds. Al three should benefit from higher oil prices and/or a more positive outlook on the industry.

Looking at the news on oil prices, you might think the sky is falling. Headlines like these -- "Crude Oil Price Outlook Bearish on OPEC Output, Fed, US-China Trade"; "Oil Rig Count Plunges to Lowest Level Since 2017"; "Oil Bulls Broken By Economic Fears"; and "Fears Of A Global Financial Meltdown Loom Over Oil Markets" -- are front and center. Even The Wall Street Journal and Forbes rang in with articles titled "Oil Prices Set to Climb? Investors Aren’t Betting on It" and "Do Falling Oil Prices Mean Trouble Ahead For Houston's Economy?"

Here is my opinion on oil prices. Brent Crude closed at $61.73 a barrel Friday. The highest it has been in the last five years is $90.56 on October 27, 2014. It dropped as low as $35.55 on January 15, 2016 before trading as high as $84.98 on October 1, 2018. A recent drop to $50.77 panicked markets and has resulted in financial reporters and analysts making a lot of gloomy predictions. So, when Goldman Sachs warned in an October 22 research note that oil prices might not have any significant upside next year, they really are not telling us anything we cannot deduce for ourselves by looking at the five year chart. We are about 30% off of the high and we are about 40% off of the lows. Oil, just like everything else, trades in cycles. Cycles are everywhere and extend into the affairs of humans, where they have the most impact on world economies and financial markets. That being said, oil prices are not crashing, oil prices are simply in the middle of a cycle. Cooler heads prevail and we would probably be wise to follow the advice of Al Czervik, who was played by Rodney Dangerfield in the movie "Caddyshack." In a classic scene from the movie, he got a call on the golf course, which was a really big deal in 1980, and said "Hello. It's my broker. What? Then buy, buy, buy! Oh, everyone's buying? Then sell, sell, sell!" If oil prices were really crashing and Brent Crude was in the low $40 range, you could make some easy money by having the intestinal fortitude to snap up some bargains by buying stocks like Exxon Mobil Corporation (XOM), Chevron (CVX), Occidental Petroleum (OXY), and Phillips 66 (PSX). But oil prices are in the low $60 range and not the low $40 range, so how do we make money? The way to make money on oil stocks is by picking companies that have been beat up as a result of the media crying wolf on oil prices. Look for good companies with honest and competent management that have been oversold. Here are a few companies I think will do well, even if oil stocks stay out of favor.

Marathon Oil Corporation (MRO) has been in the oil production business since 1887 when it started as The Ohio Oil Company. John D. Rockefeller purchased it in 1889 and it was part of Standard Oil, until the US government broke up the Standard Oil Trust in 1911. After purchasing the Transcontinental Oil Company in 1930, the Company became known as Marathon and started trading on the New York Stock Exchange. In 1982 Marathon became part of US Steel. In 2001, USX, the holding company that owned United States Steel and Marathon, spun off the steel business and, in 2002, USX renamed itself Marathon Oil Corporation. In 2003, Marathon sold its Canadian operations to Husky Energy. In 2011, Marathon Oil spun off the refining business to a separate company called Marathon Petroleum Corporation (MPC) and became an independent exploration and production (E&P) company.

Marathon Oil Corporation posted diluted EPS of $1.18 for fiscal 2018 on revenue of $5.47 billion. At $11.98 a share, Marathon Oil Corporation currently trades at a market cap of around $9.6 billion with a trailing P/E of 10.18 and a forward P/E of 23.96. It is obvious Marathon Oil is less speculative than the previous two companies I mentioned, but it still trades at a 20% discount to the $15.05 book value per share. In addition to being at the lower end of its trading range, Marathon Oil Corporation pays a $0.20 per share dividend, which yields 1.68% at the current price.

VAALCO Energy (EGY) trades on the NYSE and the London Stock Exchange. The small independent is engaged in the acquisition, exploration, development, and production of oil and gas, primarily offshore in Gabon and Equatorial Guinea. VAALCO Energy holds high-risk exploration assets in Angola and Gabon through participating in oil company consortia, and has exploration assets in Gulf Coast of Texas and Louisiana, and in Montana. VAALCO's near-term production strategy is to focus on developing its reserves in Gabon through the exploitation of the Etame Marin block (the Etame, Avouma, South Tchibala, and Ebouri fields). In 2013 the company reported proved reserves of 7.2 million barrels of crude oil, of which 46% is developed, and 1.3 million cu ft. of natural gas. For the fiscal year ending 12/30/2018 VAALCO Energy produced 3,751 barrels of oil per day (“BOPD”) net and sold 1.4 million barrels of oil (“MMBO”) net in full year 2018. VAALCO Energy also reported income from continuing operations of $98.7 million, or $1.63 per diluted share, on revenues of $104,943,000.

At $2.03 VALLCO Energy is trading at a market cap of $121 million dollars, since they have 59.6 million shares outstanding. At this price, the stock is trading at a P/E of 1.55 and slightly above its $1.94 book value per share, of which roughly $0.81 is in cash.

Ring Energy, Inc. (REI) is a Midland, Texas-based oil and gas exploration, development, and production company with current operations in the Permian Basin of West Texas, which is recognized as the top producing oil basin in North America. Founded in 2012, the experienced management team has aggressively sought to acquire select properties in the Permian Basin with development opportunities for future years. As of 12/31/18, the company has, through exploitation and acquisitions, increased their proved reserves to an estimated 36.6 million BOE’s (barrel of oil equivalents). CEO Kelly Hoffman cut his teeth in the Permian Basin. He started out in the there in 1975 with Amoco Production Company. In the early 1990’s, Mr. Hoffman co-founded AOCO and drilled 60 wells in the Fuhrman Mascho field in Andrews, Texas. After 18 months and a 600% increase in revenue, AOCO sold the properties to Lomak (Range Resources). He did the same thing again in 1999 when he acquired 12,000 acres in Lubbock and Crosby counties. After drilling and completing 19 successful wells, he sold his interest in the property to Arrow Operating Company. My take is the management team at Ring Energy knows the Permian Basin very well.

For fiscal 2018 Ring Energy had diluted EPS of $0.35 on Revenue $146.11 million. Ring Energy's Quarterly Revenue Growth year over year is 71.70%, while Quarterly Earnings Growth year over year is 162.20%. The book value per share is $7.61, so with a current price of $1.73, you are buying the stock at about a 78% discount to book. As of 06/30/2018, Ring Energy had $10,578,982 in cash, so with 67,811,111 issued and outstanding as of 06/30/2018, about $0.155 of the book value per share is in cash. One other interesting note on Ring Energy is that they have 63.97 million shares in the float and there are 8.06 million shares short. That's 15.74% of the float and about six or seven trading days to cover using their average daily trading volume. PEDEVCO Corp. (PED) announced last week the Company is in discussions with their CEO and major shareholder, Dr. Simon Kukes, to evaluate the potential acquisition by the Company (PEDEVCO) of Dr. Kukes' approximately 8.1% ownership stake in Ring Energy, Inc. Dr. Kukes announced his acquisition of the Ring Energy shares in a Schedule 13D filed the same day with the U.S. Securities and Exchange Commission.

What About Funds?

Picking stocks isn’t the only way to take advantage of a selloff in oil stocks. There are plenty of good funds and here are a few I like. Fidelity Select Energy Portfolio (FSENX) is an actively managed fund trading at $34.42, which is down about 16% from its high of $41.08 on 04/23/2019. Even though it's down now, the fund beat two-thirds of its rivals over the past five years. Fidelity Select Energy Portfolio made its debut in July of 1981 and currently has more than $1 billion in assets. John Dowd has been the fund manager since July of 2006.

If you are more comfortable with a passively managed exchange-traded fund, you can look at iShares U.S. Oil & Gas Exploration & Production ETF (IEO). According to the fund's fact sheet, iShares U.S. Oil & Gas Exploration & Production ETF has 64.37% of its assets in the oil and gas exploration and production sector and 29.4% of its assets in re­finers, such as Phillips 66, Marathon Petroleum, and Valero. These businesses make more money when oil prices are low, giving the ETF some support if the oil prices stay down here a while. The fund, which charges 0.43% annually, pays a $0.25 per share dividend, which gives investors just over a 2% yield.

Energy Select Sector SPDR ETF (XLE) tracks the energy stocks in Standard & Poor’s 500-stock index. The ETF recently held 45% of its assets in ExxonMobil and Chevron and seeks to provide investment results that correspond to the price and yield performance of the energy sector of the S&P 500 Index. Its annual expense ratio is just 0.15%, but the price of the ETF is down 15.5% from its year high. It pays a $0.56 per share dividend, which is a 3.66% yield at this price.

I appreciate the opportunity to share my opinion and hope I can provide a few ideas.

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

Additional disclosure: The information in this article is for informational purposes only and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. I am not a financial advisor. Nor am I providing any recommendations, price targets, or opinions about valuation regarding the companies discussed herein. Similarly, the disclosure above may state that I am long or short shares of the companies mentioned herein, but should not be construed as an endorsement of any particular investment or opinion of the stock’s current or future price. That disclosure is true as of the time the article was submitted to Seeking Alpha, but it is possible (or even likely) that I might be buying and/or selling the stocks mentioned herein immediately thereafter or at any other time, regardless of (and possibly contrary to) the content of this article or this website’s timing of its release. The disclosure will not be updated following submission of the article and may be inaccurate thereafter. Likewise, any opinions are as of the date of publication, and are subject to change without notice and may not be updated. I believe that the sources of information I use are accurate but there can be no assurance that they are. I wrote this article myself and I receive no compensation for writing it. All investments carry the risk of loss and the securities mentioned herein may entail a high level of risk. Investors considering an investment should perform their own research and consult with a qualified investment professional.