The energy industry can be a tough place to invest. Whether it's the unpredictable swings in oil and natural gas prices, the cyclical nature of solar and wind project development, or the uncertainty around interest rates, which impact spending across the entire sector, there are a lot of factors investors should consider before buying into an energy stock.
Moreover, it can take a lot of patience -- and sometimes the willingness to ride out an ugly downturn -- to profit from the opportunities in the sector. Most importantly, if you want stocks that can deliver solid returns, you need to focus on the best companies -- those with durable competitive advantages, strong balance sheets, and management teams with the chops to deliver.
If you're looking for the best energy investments right now, here are three that look particularly compelling: oil reservoir data specialist Core Laboratories (NYSE:CLB), leading solar panel maker First Solar (NASDAQ:FSLR), and solar and wind power producer Pattern Energy (NASDAQ:PEGI).
When messed up expectations make a great opportunity
Core Laboratories' stock price has taken a serious beating over the past few years. But it's valuation has taken a particularly ugly tumble over the past year, falling nearly two-thirds from its 52-week high. Even with signs of renewed interest from investors over the past couple of weeks -- shares are up 15% since late August -- Core Lab stock is down 44% since April alone.
On one hand, it makes some sort of sense that Core Lab shares would be down. Crude oil prices have fallen almost 22% since April, and it's not uncommon for oil industry stocks to follow the general trend of crude prices. That's particularly true for oilfield service companies -- their offerings are often among the first expenses that producers cut when oil prices decline.
The thing is, Core Lab isn't a typical oilfield services company. First, its business model is "asset light," meaning it doesn't own drilling rigs or other capital-intensive equipment that also leads to high fixed operating costs. As a result, it's far more nimble at managing the swings in demand for its services while still generating positive cash flow.
True, its operating cash flows have fallen, and its second-quarter results were underwhelming, but this is a business that continues to prove resilient and stay cash-flow positive across the entire cycle. Few oilfield service companies can say that.
Why buy now? Because there are some big catalysts on the horizon that make Core Lab look particularly compelling. One of the biggest is the recovery in offshore oil and gas development. During the 2014-2016 oil crash, investment in offshore development pretty much dried up. Spending fell for three straight years, and approvals for new development were nearly nonexistent. However, over the past two years, 50 new projects got the green light, and it's expected that another 30 will get the go-ahead this year.
For Core Lab, that should result in a big increase in demand for its reservoir description services, and the beginning of that upturn arrived in the second quarter. Most importantly, these offshore projects are massive and take many years to develop, and that should lead to strong cash flow growth for Core over multiple years as those projects come online.
Put it all together, and you have a strong, cash-flow positive business with a major catalyst, but that is trading near a 10-year low. Core Lab is a buy now.
A competitive advantage beyond its leading technology
While Core Lab has been taking a beating in 2019, First Solar has been on a tear. Shares are up almost 47% year-to-date as demand for solar panels grows. For the full year, First Solar expects to earn as much as $2.75 per share, more than twice the $1.36 per share it earned in 2018.
Its Series 6 panels are a big part of the overall package that has it so well-positioned to profit from this strong solar panel buying cycle. They offer utility-scale solar operators and developers one of the best combinations of power production and value on the market. The record 1.4 gigawatts of panels it shipped in its second quarter are proof that First Solar is continuing to win more than its share of utility-scale solar deals.
Moreover, with nearly 13 gigawatts of orders on the books, the company has a backlog worth almost two years of business, and is rapidly investing in expanding its capacity to fill those orders more quickly.
As much as First Solar's proven thin-film panels -- which First Solar regularly makes even better -- continue to provide it with one competitive advantage, investors shouldn't overlook another that could be its most powerful: a fortress of a balance sheet.
At the end of its last quarter, First Solar had more than $2 billion in cash, compared to $481 million in long-term debt (none of which will mature within 12 months). To put it plainly, this makes it much easier for First Solar to ride out the ups and downs of solar panel demand that have become typical for the industry, while also supporting its ability to continue investing in its industry-leading thin-film panel technology.
At recent prices, about one-third of First Solar's stock value is covered by the cash on the balance sheet, and shares trade for less than 23 times the high end of this year's expected earnings range. That's a reasonable price to pay for this industry leader. Considering how effective management has been at improving its technology to maintain an edge in the utility-scale solar market, and how its strong balance sheet should help it maintain that edge across every part of the demand cycle, First Solar is a rare solar panel maker that's worth buying now and holding for the long term.
The winds are changing for this yieldco
Over the past few years, renewable energy yieldco Pattern Energy has been entangled in a problem that's mostly of its own making. Soon after its IPO, Pattern began distributing a dividend, and then initiated a streak of staggering payout increases. Starting in 2014 and running all the way into 2018, the company raised its dividend every quarter.
While that was nice for investors at the time, the company wasn't retaining any of the cash it was producing, relying heavily on debt and stock sales to fund new projects. Unfortunately, it ran headlong into a potential problem, as dividend growth was outpacing cash flow growth. In response, management froze the quarterly payout at $0.422 per share in late 2017, and hasn't increased it since.
Even after locking its payout at that level, the company distributed essentially every dollar it generated in 2017 and 2018; for much of that period, there were significant concerns that it would have to cut the payout in order to improve its balance sheet and restart growth.
While it was touch-and-go for a few quarters, the company's multiyear growth plan is paying off. Pattern is now on track to grow cash flows by at least 10% this year. By 2020, management expects it will get to its target cash-payout ratio of 80%, without having to cut the dividend to get there.
And I think that makes it worth buying now. None less than Brookfield Asset Management subsidiary TerraForm Power (NASDAQ:TERP) is showing interest in merging with Pattern Energy, a sure sign that Pattern's assets are top shelf and it sells for fair value. Moreover, its dividend, yielding 6.2% at recent prices, gets more secure with each passing quarter.
Whether it merges with TerraForm, one of my favorite yieldcos, is beside the point: Pattern Energy is worth owning today.