It's been a while since oil was trading for less than $30 a barrel, back in the early months of 2016. In many instances, though, oil and gas stocks still sport valuations that would seem at home at the bottom of the industry cycle. For those who think that oil prices will rise in the next few years, adding some oil and gas to your portfolio looks awfully compelling today.
So we asked three Fool investors to each highlight a stock they think is a great buy at this point in the energy cycle. Here's why they picked Encana (OVV 0.12%), Range Resources (RRC -1.29%), and Transocean (RIG -1.43%).
A potential gusher
Matt DiLallo (Encana): Canadian shale driller Encana spent the oil market downturn repositioning its portfolio and reducing costs so it could get to the point of thriving at lower oil prices. Encana hit that pivot point last fall: It was one of the first oil companies that unveiled a plan to return to growth as the market cycle turned upward. Under Encana's initial forecast, the company could increase production and cash flow by 60% and 300%, respectively, by 2021 while mostly living within cash flow, as long as oil was around $55 per barrel. Thanks to continued innovation and efficiency gains, Encana is already ahead of pace and now estimates that it only needs oil to average $50 a barrel for its strategy to work.
One of the drivers of Encana's ability to thrive at lower oil prices is its vast inventory of premium-return drilling locations, which can earn a 35% direct after-tax return at $50 oil. But the company's current growth plan will only consume a fraction of the more than 11,000 premium locations it has accumulated. Because of that vast inventory, Encana has the potential to deliver an even greater gusher of growth if oil heads higher, which is something many analysts think could be just around the corner since the market is starting to rebalance.
In any case, Encana is a great oil stock to consider buying for the long haul since it will thrive if oil stays low -- and will offers an abundance of upside if crude takes off.
Increasing production in hopes of a rebound
Sean O'Reilly (Range Resources): Entire economies move in cycles. While some sectors of the economy are immune to these ups and downs, others know cyclicality all too well. In recent years, producers of crude oil have had to deal with an especially difficult downturn. Ever since OPEC refused to cut production in the face of rising U.S. shale production, oil companies have struggled. Now, almost three years later, there appears to be a light at the end of the tunnel. Thanks to commitments from OPEC to cut production, a balance in global supply and demand is attainable. And so, with the bottom of the oil cycle near, my pick for an oil stock to buy is Range Resources.
Though not a household name, Range Resources is a respected operator in the Appalachian Basin and Northern Louisiana. Primarily a natural gas producer, Range Resources also produces natural gas liquids (NGLs) and crude oil. Recent results have been excellent given the operating environment. Net income in the company's second quarter came in at $70 million, a marked increase over a loss in Q2 2016. Cash margins for its natural gas were $1.09 per Mcf equivalent (Mcfe) in the period, a considerable increase from the $0.70 per Mcfe in the same period last year. Perhaps most impressive, year-over-year production rose 37% to 1.945 Bcfe per day.
Range's stock currently trades at 18 times fiscal 2017 consensus analyst EPS estimates. That's an attractive valuation, especially in light of the fact that many of Range's peers barely managed to turn a profit the past few years. With production rising and shares well off their highs of over $80 per share in mid-2014, Range Resources is a fantastic energy stock to buy at the bottom of the cycle.
The deepest-value stocks are all in the deepwater
Tyler Crowe (Transocean): Oil and gas stocks have been stuck in neutral for a while as prices have remained stubbornly in the range of $45-$55 a barrel for quite some time. For some lower-cost producers such as shale drillers, this is OK because they can eke out some modest profits. Shale, however, represents only 5% of global production. OPEC and U.S. shale represent about 50% of total production, and it's that other 50% where Transocean and other offshore rig companies could see a major opportunity coming.
For a couple of years now, producers around the world have underinvested in new production sources. Instead, they have attempted to preserve cash and to focus on getting the most out of existing sources. This can only last for so long, though, because reservoir production declines naturally over time.
When the rest of the world starts to invest in new production, chances are they will look to offshore exploration, and Transocean is one of the companies best positioned to capitalize on that. Over the past few years, management has transformed the company's fleet from one of the oldest to one that specializes in ultra-deepwater and harsh-environment floating rigs. Many of these are available for work today. That isn't good for upcoming earnings reports, but it should give the company a lot of growth as producers put those rigs to work.
On top of all that, Transocean's stock trades at an extremely low price to tangible book value -- 0.3. At a price that cheap, Transocean looks like a well-positioned stock with an incredible amount of upside.