Crude oil prices have quietly had a strong start to the year. WTI, the primary U.S. oil price benchmark, is up more than 10% to around $80 a barrel. That's oil's best level since November and well above its recent bottom of around $68 a barrel in December.
Crude oil has gotten a boost from OPEC, which once again agreed to extend its production cuts, this time through the middle of the year. The group of oil-producing nations will likely continue supporting oil prices by curbing its production.
That's great news for oil stocks, which should generate gushing cash flows this year. Chevron (CVX 0.37%), Diamondback Energy (FANG 0.32%), and Devon Energy (DVN 0.19%) stand out as some of the best ways to cash in on the currently strong oil market. Their low valuations and shareholder-friendly capital return strategies make them great oil stocks to buy this month.
Upside catalysts abound
Chevron has worked hard to enhance its operations by focusing on investing in its highest-opportunity areas, like the Permian Basin. This strategy has paid big dividends by improving its returns and lowering its break-even level. At $60 oil, Chevron can grow its free cash flow by more than 10% per year through 2027.
At that price point, Chevron can produce enough cash to boost its attractive dividend (currently yielding 4.3%), invest in its high-return capital program, and repurchase shares at the low end of its $10 billion-$20 billion annual target range. That repurchase level is enough to retire 3% of its outstanding shares each year. Chevron can produce an even bigger cash flow gusher at higher crude prices. For example, it could buy back stock at the high end of its range at $70 oil (enough to retire 6% of its outstanding shares each year).
Chevron's other upside catalyst is its pending acquisition of Hess. That deal would enhance and extend its production and free cash flow growth outlook into the 2030s. Chevron estimates the acquisition would enable it to more than double its free cash flow by 2030 at $70 oil. While there were some concerns that Exxon might derail that deal, that might not be its rival's intent. Uncertainty about that merger has weighed on Chevron's stock. As that fades, and if oil prices remain at their current level, its shares could start rallying.
A blockbuster deal
Diamondback Energy has become a free cash flow machine over the past few years. The oil company generated $3.2 billion ($16.24 per share) of free cash flow last year. It returned 79% of that money to shareholders via a steadily rising base dividend, share repurchases, and variable dividends.
Diamondback Energy could produce an even bigger free cash flow gusher in 2024. At $80 oil, it could generate more than $19 per share of free cash flow. That has the company trading at a free cash flow yield of more than 10%, roughly 3 times higher than the broader market (the S&P 500's free cash flow yield is 4%, while the Nasdaq's is 3%). It suggests the oil stock is dirt cheap.
Meanwhile, like Chevron, Diamondback Energy inked a deal to enhance its ability to produce cash. It agreed to buy Endeavor Energy Resources in a $26 billion cash-and-stock deal. The company expects the merger will boost its free cash flow per share by 10% starting next year. Diamondback initially plans to return half its gushing cash flows to investors (through its base dividend, repurchases, and variable dividends) while retaining the other half to strengthen its already solid balance sheet. As debt comes down, it will have more cash to return to investors.
Shifting its strategy to capitalize on its cheap valuation
Devon Energy also produces lots of cash. At $80 oil, it could generate about $3.2 billion in free cash flow this year, 20% more than last year. The main factors driving that increase are service cost deflation and a more efficient capital program.
Like Diamondback, Devon trades at a dirt cheap price based on its free cash flow. The company's free cash flow yield would be around 9% at $75 oil and even higher at the current price point.
That drives Devon's view that its shares are a no-brainer buy right now. As a result, it has shifted its capital return framework from an emphasis on paying variable dividends to repurchasing shares. Given its cheap price, the company could retire about 3% of its outstanding shares by completing what remains on its $3 billion share repurchase program (and 9% of the total since authorizing that buyback in late 2021).
Free cash flow machines
Chevron, Diamondback, and Devon Energy built their oil businesses to generate abundant free cash flow. With crude prices rising this year, they could produce even bigger cash flow gushers. That will give them more money to buy back their dirt cheap shares, which, along with other catalysts, could help drive their stock prices higher.
