A handful of oil companies are reducing debt, raising dividends and buying back shares, yet their stocks are at multi-year lows.
With shale development leveling off and oil demand still rising for now, this would seem a good time to buy shares.
But, will demand for oils stocks ever materialize again?
Here's why these stocks should do very well in the next several years.
Two weeks ago, I published that The Peak Oil Plateau Is Close. In it, I suggested that peak oil demand would happen by 2030. That is far sooner than OPEC, oil majors, most academics, institutional investors, governmental agencies or most investors thought was possible just a few years ago.
In the past two years though, OPEC, several oil majors, the IEA and many institutional investors have come to the conclusion that oil demand is in fact on the cusp of no longer growing. On top of that, the divestment movement has been more successful than anticipated and younger investors are not showing interest in oil stocks. As a result, oil stocks have crashed in price again.
A Rebound In Oil Stocks Is Finally Coming
I have a complicated and contrarian view of where some oil stocks are headed in the next decade. While I believe that there is a wave of zombie oil stock bankruptcies coming in the next couple of years, there are also a couple of dozen oil companies poised to make a lot of money in the 2020s.
The question for investors now becomes, with the best oil companies now reducing debt, increasing dividends and buying back shares for improving shareholder yield, will their share prices appreciate ever again? I believe that answer is yes.
I think that finally, mercifully, the carnage in share prices among the better oil companies has played out. A technical pattern of price consolidation is emerging. That is, share prices are starting to chop along sideways in narrower ranges awaiting a breakout higher.
I will use the VanEck Vectors Unconventional Oil & Gas ETF (FRAK) to demonstrate some technicals since its holdings include all four stocks discussed below.
This is a long-term monthly chart. The bottom box is a measure of money flow into the group called Chaikin Money Flow. This monthly indicator is a good leading indicator for future stock price movements (though not infallible, no technical indicator is). I used the monthly chart to show that the big drift of money out of oil stock investments really has been chopping along sideways since early 2018.
The above chart is a weekly measurement. What you can see is that money flow is either bottoming or has just bottomed. These monthly and weekly charts are indicative of longer-term price movements. I skip the daily charts because those are more for day traders.
What will we see on the next monthly chart will be a move down. How do we know? November just ended, so the monthly chart will get an update and we can see the weeklies have been headed down for the past several weeks. The money flows are at or near extreme bottoms. That doesn't mean there can't be another leg down, but it does suggest a reversal is in the cards soon.
Very importantly, with oil demand still rising for the better part of a decade yet, capital investment slowing, declines accelerating and new discoveries almost nonexistent, the recipe for tighter oil supply is emerging. I believe the technical consolidation is likely reflecting that set of circumstances.
Here are three companies with dramatically improving pictures that deserve the attention of any serious value or dividend investor.
Conoco continues to streamline the company, though it still remains the world's largest independent exploration and production company. Since 2016, the company has reduced net debt from $24 billion down to $6 billion. Consider that much smaller company Chesapeake Energy (CHK) still has over $9 billion of net debt.
Conoco is planning to return approximately $50 billion to shareholders in the next decade based on very conservative oil price levels. Approximately $30 billion will be through share buybacks and another $20 billion in dividends.
Here I'd interject that $30 billion in buybacks represents about 45% of the company's market cap. This sort of capital allocation plan is becoming more common in the E&P space and says a lot about where the strongest players in the industry are headed.
The first chart in their quarterly presentation also jumped out at me.
I have used the SPDR S&P 500 (SPY) sector weighting chart to demonstrate just how far energy has fallen in the past decade. The energy sector's percentage share of the S&P 500 is down roughly 65% this decade.
That is a miserable performance for energy. We should take that in even further context. For decades, energy was always a top 3 performer in any given decade. A reversion at least to mean seems in order.
By all accounts, the U.S. economy is late in its expansion. How late is open to conjecture. Graphically, Fidelity puts the economy here:
Among sectors that do well late cycle are energy and materials.
The smart money seems to be adding to Conoco. According to 13F filings, as reported by ValueWalk, there are 10 new hedge funds with positions in Conoco. D.E. Shaw has now amassed ownership in more than 1% of Conoco.
Among ETF issuers and mutual fund sponsors, Vanguard owns over 8% of Conoco, while BlackRock (BLK) is a shade under 7% and State Street (NYSE:STT) is at about 4.6%. If oil stock ETFs start to attract investors again, then there would be considerable upward push on Conoco shares.
Of note, Conoco has been getting good sustainability marks by different watchdogs. It has been on the Dow Jones Sustainability Index for 12 years and one of six energy companies added to the S&P 500 ESG Index.
Devon Energy (DVN)
Devon Energy generated $56 million of free cash flow in Q3 on operating cash flow that rose 22% to $597 million. For the year through Q3, the company redeemed $1.7 billion in debt, reducing interest costs by over $60 million.
The company is buying back shares and the preliminary outlook for 2020 is showing a 6-8% reduction in share count based on $50 per barrel oil.
Interestingly, Devon has no debt maturities until 2025 and most of their debt is not due until the 2030s and 2040s. With the company continuing to divest non-core assets, there will be more money for paying down debt early to reduce interest expenses. In turn, that can support further buybacks and dividends.
The company operates in all of the best U.S. oil basins and has enviable positions in each (see Q3 report maps). While all of the assets are strong, it would not surprise me to see Devon sell one to further wipe out debt and focus the company. Assets include Powder River Basin, STACK in Oklahoma (most likely to be sold I think), Eagle Ford, Barnett (gas, also a sale candidate) and the Permian.
In particular, Devon's Permian Delaware Basin assets are primed for strong operating results. With new pipelines coming online now and soon, the discount on their WTI has already been shrinking. It is not unlikely that Permian oil gets a premium soon given the proximity to refining and shipping.
Devon is also included in the Dow Jones Sustainability Index. The company's ESG rating against peers is in the top quartile. Though that doesn't change that they are an oil company, it demonstrates a willingness to be transparent and in their case works towards methane emission reduction targets.
Encana just can't get any respect. So, they're leaving Canada and moving to the U.S. On the face of it this would not seem a big deal, but by moving to the U.S., they will see shares added to several ETFs, including the SPDR Oil & Gas E&P ETF (XOP). That could boost shares in coming weeks.
The continued expansion of the ETF business has been a constant conversation among investors I work with. The impact of ETFs on your stock purchases should be a consideration in every investment decision.
Their recent earnings beat estimates by 7%. That was the 4th consecutive quarter that Encana beat estimates. I believe that speaks to how well the company is executing and how badly analysts are getting it on oil still (I believe most just follow the herd and don't learn).
The earnings beat was in lieu of their despised by investors merger with Newfield. I view that merger, and most other oil patch mergers, favorably.
Most investors think there are white knights lurking to buy up oil companies for premiums. In most cases, there are not. There are private equity vultures and investors like Warren Buffett with big checkbooks. None are overpaying with sentiment so bad.
Most investors do not understand the synergies coming from companies combining assets. It is necessary for more mergers to happen. Those who have done it already are ahead in the game.
The Encana and Newfield merger is quickly proving to be a good one. The company increased synergy estimates for the third time recently. Original synergy estimates had been for annualized savings of $125 million. That now stands at $200 million.
The company recently completed a $1.25 billion buyback. It is also raised its dividend 25%. The dividend yield is now approaching 2%, though that is largely a product of a depressed stock price.
In 2020, the company will become known as Ovintiv. Nothing else really changes other than access to capital for the company and ETF money flows for the stock.
The company expects to continue reducing debt, which stands at 1.8x leverage post-merger. Its number one priority in 2020 is to continue to increase free cash flow.
The company is already trying to sell non-core assets. I would not be surprised to see the company sell a core asset in addition to non-core assets. Their STACK/SCOOP acreage could be a surprise sale as it would be a good bolt-on piece for several Oklahoma oil players.
Watch management for critical decisions in coming months. That will determine whether Ovintiv rises with the industry or is an outperformer. Encana might have the highest percentage upside for share price, but is also the highest risk.
Encana has also received a top quartile ESG rating among peers.
Go Slow Building Positions, But Start To Build
The next year could be tough on the oil sector. An economic slowdown would validate the oil bears. The divestment movement will continue. Many Millennials will probably never become interested in oil stocks.
That said, a floor appears to be getting built for oil stocks. I have thought this before, so continue to be wary even with companies finally exercising fiscal discipline and returning cash to shareholders.
Energy stocks are capping off the decade as the worst-performing sector after having been a top three performer in most other decades. A reversal would seem in order unless energy is suddenly going to become free.
If you do not own any oil stocks, I think you should start to sift through the wreckage. There are winners left in the oil patch, including those mentioned in this article and articles coming soon.
I suggest buying small starter positions in the four stocks listed above. Then, sell out of the money cash-secured puts. You can also wait to see if there is another oversold market that takes prices down another notch. Selling cash-secured puts is a strategy I do at my investment firm and with Margin of Safety Investing.
If the puts are exercised, then you have scaled in at a lower price and received premium income. If the put options expire, you simply keep the premium and have already bought a good stock near its bottom.
To get Margin of Safety Investing for half price your first year, direct message me via Seeking Alpha and put "half price" in the subject line.
Let me earn your trust. Sincerely, Kirk Spano.
Disclosure: I am/we are long DVN, ECA. 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.
Additional disclosure: I own a Registered Investment Advisor, but publish separately from that entity for self-directed investors. See relevant terms and disclaimers at the website of Bluemound Asset Management, LLC. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.