Undervalued oil stocks are out there if you know where to look.
After the pandemic contagion, when prices fell to zero, oil prices have had an epic comeback. Consequently, oil stocks posted solid gains in 2021 and 2022.
By the end of 2022, the Energy Select Sector SPDR Fund, a broad oil sector ETF, had surged 238% from its lows in March 2020. However, oil stocks have given back some gains since the recent top. Now, this pullback presents several undervalued oil stocks to consider.
There are various factors contributing to the weakness. Entering 2023, most analysts expected oil to catch a bid from China reopening. Demand would surge as travel and economic activity increased. However, the surge in demand from China has yet to materialize.
OPEC announced an unexpected production cut on April 2. These developments took analysts by surprise. Could China’s demand be weaker? Or was oil suffering due to expectations of a recession in the second half? With this uncertainty, energy sector stocks have sold off year-to-date.
However, the sell-off presents an opportunity for patient investors. Notably, entering 2023, oil stocks had the best fundamentals in the market. Indeed, they had strong earnings growth and cheap free cash flow multiples compared to other sectors.
Now, after the sell-off, there are many undervalued oil stocks. Although earnings might decline slightly from historic 2022 levels, fundamentals are solid.
Yes, a recession might hurt oil demand in the medium term. But hydrocarbons will continue powering economic activity as demand surges. So, consider these undervalued oil stocks for your portfolio.
Occidental Petroleum (OXY)
The deal saddled Occidental with over $40 billion in debt. And just as the company was planning on asset sales and operating efficiencies to pay down debt, Covid-19 struck.
Over the last two years, the company has had a remarkable resurgence. The Russian-Ukraine war and the ensuing oil spike have accelerated the return to financial stability. So far, the company has focused on aggressively paying down debt. In fiscal year (FY) 2022, the company repaid $10.5 billion in debt.
According to the latest earnings report, the company has begun redeeming preferred stock.
Due to its cost-cutting efforts, the company is massively profitable at current oil prices. Cash flow in the latest quarter hit $2.9 billion, and net income was $983 million. And it is using excess cash to buy back stock.
In the first quarter of fiscal year (FY) 2023, they bought back $752 million of common stock.
Now that debt is manageable and rapidly declining, the firm has pivoted to shareholder returns. Thus, analysts expect this undervalued oil stock to do well. Analysts have an average price target of $68.
Besides, the stock is a bargain at a forward price-to-earnings (P/E) of 10. The Oracle of Omaha also likes OXY stock. He holds over 24% of the shares outstanding. And he continues to buy more.
On May 18, Reuters reported that Buffet added $201 million worth of shares.
The company announced a $75 billion buyback after a record $36.5 billion profit in 2022. Politicians were unimpressed, claiming big oil companies were fueling inflation bythe move.
Shareholders will benefit from the buyback since it will be accretive to earnings. Besides the buyback, you get to enjoy solid dividends. The company has a solid track record of dividend payments. It is a dividend champion, having raised its dividend for 35 years.
Thus, if you are looking for solid oil stocks, Chevron is an option. It’s an integrated supermajor with one of the healthiest balance sheets and competent management. Its diversified portfolio includes oil and gas production, refining and petrochemicals.
The diversified portfolio enhances the stability of Chevron’s earnings. Second, its global refining business benefits when crude prices are weak. Third, the company’s petrochemical joint venture with Phillips 66 provides further diversification.
Management has maintained a strong balance sheet through previous oil cycles. Then, when opportunities arise, they utilize their balance sheet to make value-adding acquisitions. For instance, the Noble acquisition in 2020 and the recently announced acquisition of PDC Energy.
In terms of financial performance, the stock has been a solid performer, with record cashflows and earnings in 2022. After a 16% pullback, CVX stock is undervalued at a forward P/E of 10.5. Meanwhile, you pocket a healthy 3.89% dividend yield as you await appreciation.
Devon Energy (DVN)
Oil stocks underperformed the S&P 500 index between 2015 and 2020. Investors were unimpressed by the lack of capital discipline amid falling oil prices.
But oil companies have rationalized capital expenditure. Instead, they are focusing on returns to shareholders. Devon Energy (NYSE:DVN) pioneered pivoting to a capital discipline and return to shareholder model.
It offers a fixed plus variable dividend. Thus, as free cash flow rises, the variable component increases. Because of this change, Devon has had one of the highest dividend yields in the industry. When it delivers a great quarter, shareholders benefit as they receive a higher yield.
Management has been committed to returning excess cash to shareholders. Year to date, they have already returned over $1 billion, as highlighted in the first quarter earnings release. Underlining this commitment, the board increased the buyback by 50% to $3 billion.
After earnings, investors seemed disappointed despite the stellar results – including an all-time production record of 320,000 barrels per day. The stock sold offplummeting from October 2022 levels of around $75.
This energy stock is one of the best undervalued oil stocks.
According to TipRanks analysts, the stock is cheap. The average price target is $66 representing over 30% upside.
Based on earnings, DVN stock trades at a forward P/E of 7. It has a modest debt-to-equity ratio of 0.6. So, management will allocate a significant portion of free cash flow to buybacks and dividends.
On the date of publication, Charles Munyi did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.