Why the Energy Sector Still Provides Good Value for Investors

Weakness in this sector has caused high-value companies to trade near all-time lows. This therefore presents a unique chance for value investors to take up positions in some of these beaten down stocks at a bargain.

James Gitahi
James Kagunda
Apr 3, 2014 at 12:15PM
Energy, Materials, and Utilities

Increasing volatility in the energy sector has many investors worried, with a significant number opting to cash out. I believe that the energy sector is still a healthy investment choice, and patience is the one virtue that should be practiced here. 

For those who are doubtful that this sector is still poised for an impressive comeback, here is what the International Energy Agency thinks you should be aware of. Oil demand is set to increase this year as a result of global economic recovery, but demand in the coming months is expected to dip slightly due to seasonal consumption decline. World consumption will increase 1.5% or 1.4 million barrels of oil per day to 92.7 million barrels per day.

In light of these facts, value investors should be aware of the fact that there are some viable plays that could offer great upside in the long term. With that being said, I have chosen to focus on three companies for reasons that will become clear further into the article.

3 ways to play the sector
Chevron Corporation (NYSE: CVX), ExxonMobil (NYSE: XOM), and Seadrill Ltd (NYSE: SDRL) are some of the companies that have been major players in the energy sector for quite some time. Due to the immense number of factors at play, analysts have a mixed view, with most leaning on the bearish side. Seadrill has for instance seen a decline in its free cash flow growth over the past three years, while on the other hand it has increased and expects to further increase investments. Additionally, the constantly fluctuating day rates and reports of reduction in exploration expenditure have not been helpful in easing investor tensions. The stock has taken a blow, trading near its 52-week low of $33.

There are a couple of things I would like to point out to Seadrill's skeptics. One of the bases for this skepticism is that oil prices could hit the low $80s range in the coming months, which in my opinion is unlikely. With the uncertainty in Europe as a result of the Ukraine-Russia conflict, as well as the constant turmoil in the Middle East, there is just no way of knowing whether prices may hit this range anytime soon. Also, while it is true that Seadrill is somewhat heavily leveraged, the management is focused on reducing its debt. In fact, according to the company's fourth quarter earnings report, it is dropping down some of its assets to its subsidiary Seadrill Partners with the proceeds intended for debt repayment and increasing future dividend yields. It's also noteworthy to mention that Seadrill is about 90% fully booked in 2014.

Increasing capital expenditure in this sector has also been a major cause of concern for investors. On this front, Chevron and Exxon have been the most affected. Chevron plans to spend about $40 billion in 2014 while Exxon spent at least $42 billion in 2013. Should this trend worry potential investors? The answer is no. This is because Exxon expects the figure to go down to about $39.8 billion this year and eventually level out at around $37 billion in 2015 and 2016 while Chevron also appears to have similar projections in which its capex will flatten out in the next two years. The financials of the two companies are solid enough to handle the expected pressure from any crude oil price drops since most analysts believe that prices may hit bottom $90s range before springing back to highs of $100 in the coming quarters.

Another important thing that people seem to be forgetting is that these three companies have offered solid dividend yields for quite some time. Seadrill surpasses the two with an impressive dividend yield of about 12%, Chevron comes in second with 3.5% and finally Exxon at about 3%. Moreover, these three companies have a great dividend paying history which should be attractive for long-term value investors. We will however have to wait at least two more years before we can see significant improvement in production volume. Chevron expects an increase to at least 3.1 million barrels a day, up from 2.6 million barrels a day by 2017 while Exxon expects production to remain stagnant for the near future.

Bottom line
One thing common to these companies is that the widespread belief that crude oil demand is going to reduce while at the same time prices will fall has led to massive short selling. This has led to these three companies trading at some of their all time lows, which creates a unique window of entry for value investors. At current share prices, I believe these three companies have upside potential of at least 10%. For current shareholders this is not the time to listen to skeptics and cash out, but rather a time to increase their position and enjoy the dividend payout as they wait for the share price to rally again.