Oil prices have recovered nicely this year, up about 30% to more than $60 a barrel. That’s right in the sweet spot for most oil companies, which can generate lots of cash at that level.
However, oil prices are notoriously volatile, meaning today’s generous pricing could be gone tomorrow. With that risk in mind, we asked some of our energy contributors which oil stocks can thrive no matter what happens in the oil market. They believe the best ones are Chevron (NYSE:CVX), Devon Energy (NYSE:DVN), ConocoPhillips (NYSE:COP).
Coming out strong
Reuben Gregg Brewer (Chevron): One of the biggest reasons to like U.S. integrated energy goliath Chevron is the strength of its balance sheet. In fact, even after adding notable debt in 2020 to muddle through the coronavirus pandemic, Chevron ended the year with a debt-to-equity ratio of just 0.33 times. That’s a reasonable level for any company, and this conservative financial approach helps explain why Chevron has been able to increase its dividend annually for over three decades, making it a Dividend Aristocrat.
However, there’s something else worth highlighting about strong balance sheets: Financially sound companies have options, even when times are tough. In the case of Chevron, it was able to use the energy downturn in 2020 to acquire Noble Energy in a $13 billion deal. The acquisition augmented Chevron’s onshore U.S. drilling position and its international operations. So, thanks to its conservative fiscal approach, Chevron was able to use the downturn to strengthen its business so it would come out the other side an even more formidable industry giant.
With oil demand starting to pick up again, helping to stabilize oil prices, Chevron is already poised to benefit from the acquisition. In fact, with oil now well above $40 per barrel, the Noble deal should be accretive to earnings within the first year. But while you admire the improving results across the energy sector, remember that Chevron did something others couldn’t. And that should allow Chevron to reap the benefits of higher oil prices in 2021, in addition to the benefits of increased scale that will augment its results for years to come.
Get paid a gusher of dividends
Matt DiLallo (Devon Energy): Devon Energy is laying the blueprint for what could be the future of how oil companies allocate their cash flow. In years past, oil companies spent a significant portion of their cash flow on drilling more wells to grow their production. That strategy often failed because oil prices have been so volatile that it left them with little breathing room, often causing them to make deep cuts when prices fall, including to their dividends.
Devon’s approach is to invest just enough money to maintain its production rate. That leaves it with plenty of room to cover its base dividend. Meanwhile, it uses up to half the remaining cash flow each quarter to pay a variable dividend. The rest goes toward enhancing its already strong balance sheet and targeted growth investments when market conditions warrant expansion.
That variable dividend program sets Devon apart because investors immediately benefit from higher oil prices. For example, the company paid a $0.19 per share variable dividend during the fourth quarter, nearly double its $0.11 per share base quarterly payout. With oil prices improving since then, its next variable dividend will likely be even bigger.
As the oil market improves, Devon can spend some additional money on growing its production in the future. However, in the meantime, investors get paid well while waiting for that recovery thanks to its variable dividend program. That strategy sets investors up to potentially collect a gusher of income if oil prices continue improving, which could fuel attractive total returns.
Bigger shareholder returns in the offing
Neha Chamaria (ConocoPhillips): Oil companies with a strong cash-flow profile are primed to benefit from a recovery in the oil market. ConocoPhillips is pretty well set on that front for two reasons.
In its recently announced preliminary guidance (first-quarter numbers will be released in the first week of May), the upstream oil company reaffirmed its full-year capital spending target of $5.5 billion. So despite the oil market recovering, ConocoPhillips is determined to hold its purse strings tight on growth expenditure for now and instead focus on sustaining capital expenditures (capex) to keep production flat at 1.5 million barrels of oil equivalent per day. In a rising oil price environment, flat production and low capex should free up a lot more cash for the company. For perspective, ConocoPhillips generated cash from operations worth $5.2 billion in 2020.
In fact, in what can be seen as a reflection of management’s confidence in the company’s cash-flow growth potential, ConocoPhillips is among the few oil companies to resume share repurchases after pausing it during last year’s oil slump. Here’s the thing: ConocoPhillips is committed to returning 30% cash from operations to shareholders. The resumption of its share repurchases, over and above stable dividends, is therefore a clear-cut indicator that the company is on track to generate substantially higher amounts of cash flows this year. ConocoPhillips’ first-quarter report will also give investors a glimpse of how the company’s large recent acquisition of Concho Resources is faring. It’s a big growth move, which further adds to the 3.2%-yielding oil stock’s appeal.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.