Crude prices haven't behaved as expected this year, ending the first half down double digits and settling in the mid-$40s. That sell-off in the oil market has taken most oil stocks down with it, including several that are doing just fine at lower oil prices. Three that caught our eyes as being unfairly beaten down despite their prospects are Kinder Morgan (NYSE:KMI), Royal Dutch Shell (NYSE: RDS-A)(NYSE:RDS-B), and Helmerich & Payne (NYSE:HP). Here's why we think that July is a great time to buy this oil trio.
A cheap stock with a catalyst up ahead
Matt DiLallo (Kinder Morgan): Energy infrastructure behemoth Kinder Morgan's stock has slumped about 6% this year due in part to the 17% dip in the price of crude. While sliding crude has some impact on the company since it does produce quite a bit of oil, it has 78% of this year's production hedged at $59 per barrel, which is well above the current price. Further, 91% of its earnings come from fee-based pipelines and terminals, which generate rather steady cash flow no matter what prices are doing. Add it up, and 97% of its cash flow is either hedged or fee-based, which is why Kinder Morgan fully expects to generate $4.46 billion of distributable cash flow this year, or about $1.99 per share.
That number is worth noting because, at the company's current mid-$19 stock price, it's trading at less than 10 times distributable cash flow, which is an embarrassingly cheap price for a solid pipeline stock like Kinder Morgan. That said, Kinder Morgan offers investors more than just a cheap stock price since it also has an important catalyst on the horizon. One of the company's priorities upon entering 2017 was to secure financing for its largest growth project, which it recently accomplished by completing an IPO of its Canadian business. With that funding in place, the company will start generating significantly more cash flow than it needs for reinvestment.
While it has several options for that cash flow, the company noted when it completed the IPO of its Canadian unit that it "remains on track to announce revised dividend guidance for 2018 in the latter part of this year, consistent with the previously announced goal of returning additional value to shareholders." Since the pipeline giant currently only pays out about a quarter of its cash flow in dividends, it could unveil a monster dividend increase for 2018 considering most peers pay out more than 50% of their cash flow in dividends.
Given that looming catalyst of a potentially massive dividend increase later this year, it's likely that Kinder Morgan's stock won't remain cheap for much longer, which is why investors should consider pouncing on this opportunity in July.
Big oil's biggest dividend is looking safer
And while there's still risk a that Shell will have to reduce its payout, that risk seems to be going lower with each passing quarter. Both operating and free cash flows have rebounded strongly the past two quarters, even as oil prices continue to bounce along at about half levels from three years ago.
It's not just improved cash flows, either. At the outset of 2017, the company said it would sell off $30 billion in lower-return assets this year, both to raise cash to reduce debt, and as part of its plan to improve returns. Through the end of the second quarter, Shell had already sold or signed agreements to sell $21 billion of these assets, putting it well on its way toward the bigger goal.
Shell still has a higher risk profile than its peers because it has far less margin of error to maintain its dividend. But with a stock price that's down more than 8% from the 2017 peak, the market doesn't see the same improvement. For investors willing to take on this risk, the reward could be a dividend yield near 7% at recent prices, and very real potential for capital appreciation when the market decides Shell's turnaround is real.
This top-notch company could surprise lots of people this year
Tyler Crowe (Helmerich & Payne): So much of the financial media is focused on the recent decline in oil prices and what it could do to OPEC and the global supply of oil. What they are missing in all of this hullabaloo is the fact that U.S. land drilling is going strong. That may not mean much for producers -- lots of volume at low prices doesn't necessarily translate to high profits -- but it does mean quite a bit to Helmerich & Payne.
As of today, shares of Helmerich & Payne trade at a price to tangible book value of 1.35 times, one of the lowest valuations over the past 10 years. In fact, that is close to the same valuation this stock had at the bottom of the oil price crash in January of 2016 when oil was below $30 a barrel. The reason so much of Wall Street is bearish on this stock is that they foresee a plateau for oil and gas drilling activity in the U.S. Even if that were the case, Helmerich & Payne's financial position is much better today than it was 18 months ago when its stock was trading at these lows.
At the nadir of U.S. oil and gas drilling activity, Helmerich & Payne had about 87 of its 350 U.S. land rigs in operation. As of its most recent investor presentation in June, that number was up to 191 and likely growing slightly. Granted, it cost the company quite a bit of money to quickly put all those rigs back into the field, but those one-time costs are over and will likely lead to much better earnings results in the coming quarters.
This situation appears to be a gross undervaluation of what is arguably one of the best oil services investments out there. After all, what other oil services company can tout an uninterrupted streak of 44 consecutive years with a dividend increase and counting. If there is an oil stock to buy in July, Helmerich & Payne should be near the top of the list.
Jason Hall owns shares of Kinder Morgan and Royal Dutch Shell (B Shares). Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan, long January 2018 $30 calls on Kinder Morgan, and short December 2017 $19 puts on Kinder Morgan. Tyler Crowe has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool has a disclosure policy.