Oil and gas investors have had a rough go of it lately, as energy has been the worst-performing sector, falling 45% against the 59% rise of the S&P 500 over the last five years.
Oil and gas is a tricky industry to invest in, but like most industries, there are winners if you know where to look. Here's why I'm picking Chevron (CVX 0.57%) as my top oil stock to buy right now and hold over the next several years.
Image source: Getty Images.
Industry-leading balance sheet
It would be challenging to find an integrated oil and gas company with a better balance sheet than Chevron. Fool contributor Reuben Gregg Brewer agrees that Chevron's balance sheet makes it a premier oil stock -- especially in this market.
Although Chevron took on more debt this quarter in an effort to keep its liquidity high, the company sports an impressive AA credit rating, meaning it can tap into the debt market at an attractive interest rate. Its low debt-to-capital and debt-to-equity ratios indicate it has ample capacity to increase debt if needed.
Oil Industry Balance Sheet Comparison, data by YCharts.
Chevron leads most of its competitors in these two key financial metrics: something to note in this challenging energy market.
Resilience in the face of low oil prices
Even with arguably the best balance sheet in the business, Chevron still depends on the price of oil.
After briefly going negative on April 20, West Texas Intermediate (WTI) oil prices have enjoyed a steady rebound and spent all of June and July above $35 per barrel. In July, prices were very stable, hovering right around $40. WTI oil sits at just above $42 at the time of this writing.
Chevron management was keen to address the concern of lower oil prices during the company's second-quarter earnings call. Chevron CFO Pierre R. Breber noted that Chevron "can have two years at $30 Brent [and continue to] invest in the business, sustain our dividend, and still exit ... 2021 with a net debt ratio less than 25%, which we think is still a very strong balance sheet." Chevron finished the second quarter with a net debt ratio of 14%.
A hearty dividend
Speaking of its dividend, Chevron and U.S. competitor ExxonMobil are the only two energy companies that hold the coveted status of Dividend Aristocrat, a designation given to any company in the S&P 500 that has increased its base dividend for at least 25 consecutive years. Chevron has increased its dividend for an impressive 32 consecutive years. And in the last 10 years, it has increased its dividend by 79%.
Management is intent on cutting spending and ensuring ample liquidity so that Chevron remains a premier dividend stock. In fact, Chevron's Q2 capital expenditures came in 40% below its quarterly budget. The company now expects full-year capex to be just $14 billion, which is significantly lower than its initial guidance of $20 billion.
Timely acquisition
Even with that spending cut, Chevron has shown time and time again that it has the patience to back out of a bad deal and strike when the time is right. That discipline was recently put on display, as Chevron announced plans to acquire Noble Energy (NBL) for $5 billion in stock and the assumption of $8 billion in debt.
Like its attempt to purchase Anadarko last year, Chevron's Noble Energy play is intended to enhance its production capabilities in the Permian Basin, the largest onshore oil field in the U.S. But unlike the costly price the company would have paid for Anadarko, this deal looks like a much better value for Chevron.
For starters, Chevron paid only a 12% premium for Noble Energy, offering Noble investors 0.1191 Chevron shares in exchange for each Noble share. For comparison, Chevron's bid for Anadarko came at a 37% premium. Although Chevron has reduced its Permian capital expenditures by 75% compared to the first quarter of 2020, the region remains one of Chevron's primary growth drivers. It may take time for the acquisition to pay off, but getting a good price for Noble during a weak market is a testament to the value of Chevron's balance sheet strength.
The best way to invest in oil
Chevon's balance sheet, ability to handle lower oil prices, dividend strength and yield, and savvy deal-making are four excellent reasons why the company is a great way to invest in oil and gas. The timing could be good too, as its shares are down 28% year to date and yield 5.9% at the time of this writing.
As with other oil and gas companies, there is a significant amount of risk that comes with the territory of investing in the industry. Chevron remains in "prove it" mode, having underperformed the market for several years. There's no harm in waiting until Chevron and the rest of the energy sector prove they can compete with the broader market, but at the very least I would recommend adding Chevron to your watch list or picking up an introductory position now.
