With the oil and gas industry waking back up after a long slumber, investors are likely looking to add some energy stocks to their portfolios. With so many options out there, though, it can be hard to pick the right one.
So, we asked two of our energy contributors to highlight a couple of oil and gas stocks on their own radars. The two they selected were EOG Resources (NYSE:EOG) and Transocean (NYSE:RIG). Here's a quick run-down on why each is a stock worth buying this year.
The best of both worlds
Matt DiLallo (EOG Resources): The oil market appears to be improving, which has oil companies getting back to work drilling wells. However, while most producers are focused on growing production to capture higher prices, EOG Resources' focus is on earning the best returns it can in any market environment. To reach that goal, EOG set a high hurdle rate, which is that a drilling location must achieve a 30% after-tax rate of return at $40 oil before it considers using that site to fuel growth.
While this initially eliminated a large swath of drillable inventory, it forced the company to get creative to improve returns. For example, EOG found that drilling longer horizontal wells can significantly improve results, so it started strategically acquiring adjacent acreage. Meanwhile, it tested innovative well completion designs using more sand, which has also improved returns. As a result, its inventory of premium wells has increased significantly over the past year so that it now has more than a decade of locations it can use to drive growth going forward.
It is such a bountiful resource position that the company projects it can increase its production by a 15% compound annual rate through 2020 while living within cash flow at just $50 oil. Meanwhile, if crude averages $60 per barrel, it can accelerate its growth rate up to 25% compounded annually. Those growth rates blow the competition out of the water, with most rivals needing crude north of $55 per barrel to come close to delivering double-digit annual output growth within cash flow.
Because of this flexibility, EOG Resources offers investors the best of both worlds for the current environment, making it the perfect oil stock to buy this year. Not only can it thrive if prices meander along in 2017 by delivering exceptional returns and substantial growth at lower prices, but it has the ability to ramp up growth and returns quickly should prices start running up, giving investors the ability to capture that upside.
Where the deep value lies
Tyler Crowe (Transocean): For investors who want an opportunity to buy a stock in oil and gas now with hopes of a little longer-term payoff, I think Transocean is the stock worth looking at.
From a business standpoint, it's a solid, well-run company in a part of the industry that's still feeling the pinch. Oil and gas producers -- the ones that hire Transocean's rigs -- have still been a little gun-shy about spending big on offshore development. Part of that is because the price of oil hasn't risen enough to justify the higher costs related to these kinds of developments, but another reason is that shale drilling in the U.S. is taking a lot of those capital spending dollars as of late. The faster returns on shale are allowing companies to quickly take advantage of rising oil prices and put some much needed cash in their coffers.
While shale's role in the global oil market is fairly well cemented, it alone won't be enough to meet the needs of growing global demand and replace the decline at existing reserves. When this happens, producers will turn to the offshore market again and look to rent out Transocean's rigs.
It also helps Transocean's case that it has completely transformed its fleet in recent years. It has gone from owning one of the oldest fleet of rigs to owning a huge fleet of new, high-specification rigs capable of handling the most challenging drilling work. It also helps that it was able to do this fleet turnover without completely blowing up its balance sheet. Based on management's perspectives, it has plenty of cash on hand and available liquidity to see it through at least a few more years of market weakness.
The other component that makes Transocean an attractive investment is that its stock price is so cheap today. At a price to tangible book value of just 0.3 times, that is a great price to pay in 2017 in anticipation of a market turnaround.