Oil prices have continued to cool off after a red-hot run earlier this year following Russia's invasion of Ukraine. West Texas intermediate, the primary U.S. oil price benchmark, recently dipped below $80 a barrel on concerns that demand will decline if there's an economic downturn. That puts crude well off its peak of more than $120 a barrel earlier this summer.
While oil companies won't make as much money at $80 a barrel as when crude was in the triple digits, they can still generate lots of cash at that price point. That means many oil stocks are still pretty cheap based on the cash flows they can produce at the current level. Here's a look at a few of the bargains across the oil patch that value investors won't want to miss.
Gushing cash flows
Devon Energy (DVN 1.89%) has been generating prodigious amounts of free cash flow this year. It produced a record $2.1 billion of free cash in the second quarter. Devon followed that up with a strong $1.5 billion of free cash flow in the third quarter, even though oil prices were much lower.
The company expects to produce a lot of cash in the fourth quarter. Thanks to the recent acquisition of two cash-gushing oil properties, Devon expects its free cash flow to grow 25% year over year in the fourth quarter. That annualized pace of around $5 billion implies it trades at a 9% free cash flow yield at $80 oil.
That's significantly cheaper than most other stocks. For example, the S&P 500 trades at an average free cash flow yield of 5%, while the Nasdaq's is around 4%. This valuation is leading Devon to use some of its oil-fueled cash flows to buy back its cheap stock. Since launching the program, the company has spent $1.3 billion to repurchase 5% of its outstanding stock.
Adding more sources of free cash flow
Diamondback Energy (FANG 1.84%) has become a free cash flow-producing machine this year. The Permian Basin-focused oil producer generated a record $1.3 billion of free cash flow during the second quarter, exceeding its prior peak by 35%. It produced nearly $1.2 billion of free cash in the third quarter even though oil prices cooled off. That has the company on track to produce more than $4.3 billion of free cash this year, assuming oil averages around $80 a barrel in the fourth quarter. That's a significant improvement from the $2.4 billion of cash it produced last year. With a current market cap of $27.1 billion, Diamondback Energy trades at 6.3 times its 2022 free cash flow estimate or a 15.9% free cash flow yield.
While higher oil prices have helped boost Diamondback Energy's free cash flow this year, it recently agreed to make two cash-gushing acquisitions to bolster its future cash flow. It's paying a combined $3.3 billion in cash and stock to buy FireBird Energy and Lario Permian. The company expects those additions to generate $570 million of free cash flow next year, implying that it bought them at a 17% free cash flow yield. Add that incremental cash flow to the company's ability to produce cash at $80 a barrel, and Diamondback still looks really cheap these days. Diamondback seems to agree. It doubled its share repurchase authorization to $4 billion and has already spent $1.2 billion on buybacks.
Getting even cheaper
Marathon Oil (MRO 2.03%) is also producing an enormous amount of free cash flow this year. It's on track to generate $4.1 billion in free cash. The oil company is assuming $88 a barrel for WTI in the fourth quarter to reach that number. If correct, it trades at around a 17% free cash flow yield at the quarter's annualized free cash flow projection. Even if it's wrong, Marathon is still pretty cheap.
Another factor driving that view is that, like Devon and Diamondback, Marathon is using some of its cash flow to make a cash-gushing acquisition. It recently agreed to pay $3 billion for Ensign Natural Resources. It's buying that company at a 17% free cash flow yield, and Marathon expects the deal to boost its free cash flow by 15% next year.
That makes it look even cheaper. Marathon certainly believes it's cheap. It repurchased $1.1 billion of its stock in the third quarter alone. Marathon has now repurchased $3.4 billion of its stock, retiring 20% of its outstanding shares since last fall. Meanwhile, its board boosted its buyback authorization by another $2.5 billion to continue gobbling up its cheap shares.
Compelling values
While oil prices have come off their peak, many oil stocks are still cheap based on the cash flows they can produce at $80 a barrel. Meanwhile, several oil companies have used some of their oil-fueled cash flows to acquire additional cash-gushing oil properties. That will help mute some of the impacts of lower prices, further improving their value proposition. It's making the oil patch a good area for value-focused investors to go bargain-hunting.
