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Big Oil Still Undervalued, Despite Crude Run-Up (Correct)

Richard Cox

07/11/13 - 06:00 AM EDT
(Corrects story originally published July 11 to say the Exxon dividend yield is 2.7%.)

NEW YORK ( TheStreet) -- Recent rallies in oil prices will have a significant impact on broader stock values and consumer spending, made worse by this week's surge above $105 a barrel.

But with prices holding at these heights, investors should consider moving into stocks in the energy space.

Surprisingly, what makes these choices most attractive is the fact that some of the biggest integrated oil companies have underperformed relative to the S&P 500 in the last 12 months -- with some actually showing bearish performances year-to-date. With the S&P 500 gaining more than 17% during the same period, the divergence is striking.

Evidence of stronger demand and weakening supplies have been seen alongside disruptions in the Middle East, and this creates a bullish scenario for one of the market's most undervalued sector.

U.S. crude stockpiles fell again this week, with a drop of 9 million barrels. This was far larger than the 3.8 million barrel supply decline that was expected by analysts, and this sent prices to their highest levels since May of last year.

Gasoline supplies were also lower (by 3.5 million barrels), creating additional evidence that summer demand has picked-up.

This creates opportunities for investors on all time horizons, as long-term demand for oil will continue to build in emerging markets, as well.

Here we will look at three undervalued oil companies with a consistent record of profitability and strong dividend yields. These combine to offer high probability opportunities, even if oil stocks continue to stall relative to the rest of the market -- as elevated dividend payouts help offset any near-term sluggishness.

In recent years, ConocoPhillips (COP) has gone to great lengths to streamline its operations and focus on its most profitable businesses. This puts the Conoco in an unusual position in the industry, as it directs nearly all of its efforts toward exploration.

The company has seen improvements in its balance sheet after selling some of its less-profitable businesses, with significant reductions in debt and a better allocation of resources devoted to its most successful operations.

Valuations remain low, with the stock's P/E seen at 10.8, and its 4.2% dividend yield make it attractive, even for those that see near-term weakness in the sector.

In its attempts to emerge from the Deepwater Horizon rig disaster in the Gulf of Mexico, British Petroleum (BP) has been involved in major restructuring efforts that have been marked by major asset sales in various locations around the world.

Like ConocoPhillips, these activities have allowed the company to refocus its efforts and strengthen operations in its most profitable businesses. Most surprising is that BP has maintained a relatively healthy balance sheet, even after absorbing settlement costs incurred after the massive oil spills from 2010.

These events did prompt the company to put a hold on its dividend payouts, but these were offered again in 2011 and have been raised steadily since then. The stock's dividend now stands at 5%, and, with a P/E of 6, BP's worst days are behind us. Last, we look at Exxon Mobil (XOM), which is the largest independent energy company in the world.

Exxon's operations are much more diversified than those of the other two companies. Exploration and production activities generated roughly two-thirds of the company's revenues last year, with its refineries making up most of the remainder.

Part of Exxon's focus is to build on its position the country's largest producer of natural gas, and this is likely, given the size of its capital spending budget.

Dividend yields in the stock are seen at 2.7% and its P/E of 9.4 supports the argument for additional upside. Add to this Exxon's strong cash flow and stable balance sheet, and you have another opportunity for stable investment in an undervalued sector.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.


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