The energy sector is surely out of favor right now. The surge in gasoline demand in the summer driving season was quickly overshadowed by rising coronavirus cases.
While climbing cases is clearly a concern, energy stocks may get a little boost if OPEC extends oil production cuts. With uncertainty ruling the roost, investors will do best by investing in energy stocks that are likely to perform well irrespective of oil prices. Three such stocks are Chevron (CVX 2.58%), Kinder Morgan (KMI 1.81%), and Valero (VLO 3.26%). Let's look at why you should consider buying these stocks right now.
Among the integrated oil majors, Chevron easily stands out for its strong balance sheet. In uncertain times, that is a crucial differentiator.
A healthy balance sheet gives Chevron some wiggle room when earnings slump. It also places the company in a better position to maintain its payouts during these tumultuous times. Chevron lowered its planned capital expenditures quickly in response to lower demand for oil products. The other key factor that sets the company apart from its peers is its low production costs. In a low price environment, low production costs are crucial for oil and gas producers' survival.
Most oil companies have reduced their exploration and production spend in response to lower demand. If this continues, global demand for oil products may materially exceed supply, pushing prices higher. That would be bullish for top oil and gas stocks like Chevron.
A strong balance sheet and low-cost production positions Chevron well for any bullish movement in oil prices. At the same time, its yield looks safe should oil prices linger at current levels. The stock is down 28% year to date, offering an attractive entry point for long-term investors.
Though COVID-19 will affect the global demand for natural gas, it is still expected to grow at an average annual rate of 1.5% through 2025. Natural gas production in the U.S. is expected to rebound quickly, even as consumption is likely to remain relatively flat. The export market is expected to absorb any excess production. The positive outlook for natural gas is bullish for Kinder Morgan due to its strong asset footprint, both in the domestic and exports market. It moves roughly 40% of all the natural gas consumed or exported from the U.S.
Kinder Morgan's other key strength is its contracted cash flows. Roughly 68% of the company's earnings are backed by take-or-pay contracts. Customers under such contracts must either use the contracted transport or storage capacity or pay a penalty if they can't use it. Roughly 24% of Kinder Morgan's earnings are from fee-based contracts. Around 6% of its earnings are hedged to minimize the effects of commodity price fluctuations while only 2% earnings are exposed to changes in commodity prices.
Such contract structures provide some safety for Kinder Morgan's earnings during periods of volatility. That is one reason behind just a 10% expected impact due to the coronavirus on the company's previously guided 2020 distributable cash flow.
Midstream operations not directly affected by commodity prices, improved leverage, and a positive outlook for natural gas all make Kinder Morgan a buy. The stock is down 34% year to date and offers an extremely attractive yield of more than 7%.
Refiners are facing one of the most challenging times in history. Excess product supply coupled with lower demand has taken a toll on refining margins. Valero Energy's refining margin per barrel of throughput squeezed to $4.10 in the third quarter compared to $10.00 per barrel in the year-ago quarter. It fell further compared to an already squeezed second-quarter margin of $5.10 per barrel, reflecting the headwinds that the sector faces today.
While the demand for gasoline has recovered from the lows seen in April, it still remains lower compared to the start of the year.
Margins should improve over time either with a recovery in demand or closures of high-cost refineries. Until then, refining stock prices, including Valero, may remain under pressure.
There are several factors that better position Valero for an eventual recovery. Valero's cash operating expenses per barrel of throughput are one of the lowest among its peers. Moreover, Valero's renewable diesel operations place it well to benefit from the growing demand for renewable diesel. Several U.S. states are exploring and debating policies in line with those in California and the EU.
The stock currently offers an attractive yield of 7.2%, surely not bad while you wait for it to recover.