If the past few years weren't already an indication, the oil industry is an intensely cyclical one. That volatility can scare away many investors from this industry, but those with a nose for value stocks might find lots of great buys in this downtrodden industry.
So we asked three of our Motley Fool contributors to each highlight a stock they see as a great buy now. Here's why they picked oil refiner HollyFrontier (NYSE:HFC), equipment manufacturer National Oilwell Varco (NYSE:NOV), and integrated oil and gas giant BP (NYSE:BP).
Bigger isn't always better in oil refining
Rich Smith (HollyFrontier): It's a good rule of thumb that oil refiners earn more profits when oil prices are falling than when oil prices are rising. So with WTI crude oil -- which cost upwards of $70 a barrel in October -- now selling in the low $50s, I was scanning oil-refining stocks for bargains lately, and one stuck out: HollyFrontier.
With a market cap of $9.6 billion, HollyFrontier is only a fraction of the size of oil refiner giants like Marathon, Valero, or Phillips 66. At the same time, Holly sports a profit margin (8.5%) much stronger than any of those worthies. As a result, Holly earns better profits, and scores better on P/E, than pretty much any other refiner you might care to compare it to -- just 6.7 times earnings, in fact.
Another thing I like about Holly is its very reasonable debt load -- just $1.3 billion net of cash -- which is, again, just a fraction of the debt burdens of its rivals. If you're factoring debt into your valuation calculations, as I think you should, that's another plus for HollyFrontier.
One area where Holly doesn't compare as favorably to its peers is dividend yield. Holly only pays a 2.5% dividend yield versus 2.9% at Marathon, 3.5% at Phillips, and 4.6% at Valero. Then again, with a P/E this low, and arguably one of the best balance sheets in the business, I think I'd be willing to forgive Holly that one small flaw. Unless you expect oil prices to rise and keep on rising, I think HollyFrontier is a fine oil stock to buy right now.
There's lots of pent-up demand for equipment, and one company will supply the majority of it
Tyler Crowe (National Oilwell Varco): Oil and gas is an industry that is hard on the equipment it uses. Drilling for miles underground at high pressure and sometimes in hard environments means equipment needs to be replaced on a regular basis. For the past few years, though, companies have been putting off buying new equipment because oil prices have been cheap and cash-strapped businesses have run equipment harder and longer to eke out some sort of profit.
This can't go on forever, of course, and the replacement cycle will eventually catch up to the industry. When that happens, National Oilwell Varco will likely be the one to supply that equipment. It has a dominant market share in many oil equipment segments such as drilling packages (all the equipment needed for drilling) for offshore rigs. What's more, the lack of spending in the oil patch over the past several years has led to a dearth of development projects. A small queue of projects over a long period of time could potentially lead to a supply shortage, which would eventually lead to lots of spending on new developments.
While National Oilwell Varco's results haven't been too encouraging in recent quarters, the company has managed through this long downturn in spending rather well. More importantly, though, there are signs that spending is about to pick up. When that happens, it's probable that National Oilwell Varco will capture a large portion of that spending and it will likely lead to much better earnings reports in the not-too-distant future.
When the going gets tough
John Bromels (BP): Nobody's sure what's going on with oil prices these days. During the last quarter of 2018, the Brent Crude spot price fell 38.9%, sparking fears that we were heading back to the days of sub-$40 oil we saw from 2014-2017. This year, though, the energy markets shrugged off the bears, and Brent Crude has risen more than 10% again, to about $60 per barrel.
But there's no guarantee that oil prices won't move south again, and that's why British oil major BP is a solid choice among oil companies right now. Not only does it sport a nearly best-in-class dividend yield of 6.2%, but BP has shown that it can continue to cover its dividend even when oil prices are low. That's thanks to its lucrative downstream (refining and marketing) operations, which aren't as directly dependent on the price of oil as its upstream (exploration and production) arm.
That's not to say that BP doesn't do well when oil prices are high. On the contrary, in its most recently reported quarter, Q3 2018, BP's net earnings soared 93.2% higher over the prior year, thanks mostly to strong crude prices. But during the aforementioned oil price slump, BP was still able to circle the wagons, cut expenses, and hold its dividend payout steady, even as smaller companies were cutting their dividends.
The oil and gas space doesn't look quite as enticing as it did a year ago, but whether things change for the better or the worse, BP should be able to reward investors with a comfortable payout and better-than-average performance compared with the rest of the sector.
John Bromels owns shares of BP, HollyFrontier, and National Oilwell Varco. Rich Smith has no position in any of the stocks mentioned. Tyler Crowe owns shares of National Oilwell Varco. The Motley Fool owns shares of and recommends National Oilwell Varco. The Motley Fool has a disclosure policy.