Editors' pick: Originally published March 11.
Former Senate Minority Leader Everett Dirksen (R-IL) once famously said: "A billion here, a billion there, sooner or later it adds up to real money." He was referring to the nation's finances, but his remark could easily apply to many deeply indebted companies right now in the energy patch.
How colossal is the energy sector's total debt? According to recent analyst estimates, the amount of outstanding loans and lending commitments to the energy industry that large U.S. banks currently have on their books totals $123 billion.
With energy prices still at historic lows, it's no surprise that the number of expected bankruptcies in the energy sector this year now hovers at 500. Former high-flyers such as Chesapeake Energy and Linn Energy are quickly shedding assets to make ends meet.
With oil prices seemingly on an upward trajectory, many investors looking for growth opportunities are eager to jump back into energy stocks. Problem is, you need to be judicious or you could get burned. Oil prices may have finally hit bottom, but a vast oil glut still exists and global growth remains uncertain. Oil prices have been choppy and they could easily head south again.
In this unpredictable climate, your smartest strategy is to look for energy stocks with the lowest ratios of long-term debt-to-equity. They're less vulnerable to wild oil price swings and they'll grow the fastest if the oil rebound has legs.
Below, we pinpoint three S&P 500 companies in the energy sector with particularly low long-term debt-to-equity. They're among a group of high-growth stocks that should beat the market in a year that's likely to stay volatile and risky.
The total debt-to-equity ratio is a gauge of a company's financial leverage. A high debt-to-equity ratio reflects higher financial risk because of potentially higher interest costs associated with the debt and the future need to either pay back the debt or roll the debt forward with new financing.
Before energy prices started their downward march in late 2014, many energy companies (especially North American shale producers) took on huge debt to aggressively expand. Crude appears this week to have bottomed out, with West Texas Intermediate (WTI) now at slightly over $38 a barrel. That's a 26% rise over the last month or so, but still 67% lower than oil's high of about $114 in midsummer 2014. With far less revenue coming in, many energy companies have found themselves over-leveraged and desperate for cash. Some, like Chesapeake, now face an existential crisis.
With the average long-term debt-to-equity ratio of the energy sector currently at 39%, we've pinpointed three energy companies with excellent growth prospects and comparatively lower debt:
Phillips operates through four segments: midstream, chemicals, refining, and marketing and specialties. A major holding of Warren Buffett's Berkshire Hathaway, Phillips enjoys high margins from its refining and chemicals activities, which are benefiting from economic recovery and are less vulnerable to oil price swings.
PSX's trailing 12-month price-to-earnings (TTM P/E) ratio of 11.11 is cheaper than the industry's TTM P/E of 14.39. With the stock now trading at $85.85, the analyst one-year price target on the high end is $105, implying a potential gain of 22.3%.
Chevron generates revenue and cash flow from a diversified mix of assets, including liquefied natural gas, deepwater platforms around the world, shale plays in North America, and downstream activities such as refining and retailing. When any single business segment slows, others compensate. In particular, robust refining margins have helped offset the steep decline in deepwater exploration and production.
With a TTM P/E ratio of 38.29, Chevron trades at a premium to the average of its peers (21.87). But growth prospects are excellent. With the stock now trading at $93.82, the high-end, one-year price target of analysts is $122, implying a gain of 30%.
This refiner is a haven amid the energy sector's wild price swings. To understand why, you need to examine the spread between WTI and Brent crudes. WTI is now selling at about $38.67 a barrel; Brent is selling at about $40.50. Valero buys WTI as an input but prices its products based on more expensive Brent. The cheaper WTI becomes in relation to Brent, the more profits that refiners such as Valero make.
Further insulating Valero from the volatility of energy prices is the shortage of refineries in the U.S. Most refineries in the country run at nearly 100% capacity, regardless of the ups and downs of oil prices, because there's a shortage of them and regulatory hurdles make it daunting to build new ones.
With a TTM P/E ratio of 8.06, VLO is cheaper than the average of its peers (14.39). VLO shares are now trading at $64.35; the high-end, one-year price target of analysts is $100, implying a gain of 55.4%.
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