Boy, did the first half of 2018 fly by. It’s been a whirlwind year already, especially for energy stocks. At the beginning of the year, Brent crude was $65 a barrel, and people thought it was headed for another dip. Six months later, Brent has gained even more ground, touching $80 a barrel at one point.
While we aren’t prognosticators on crude oil prices, there does appear to be a lot of value in the energy sector at this price level. So we asked three Motley Fool investors to highlight a stock in the sector they like this month. Here’s why they picked Enterprise Products Partners (NYSE: EPD), Enbridge (NYSE: ENB), and Transocean (NYSE: RIG).
Investors will eventually catch on
Reuben Gregg Brewer (Enterprise Products Partners LP): Normally when a midstream limited partnership has distribution coverage of 1.5 times, investors get excited about the potential for future distribution hikes. But not at industry giant Enterprise Products Partners, which has already explained that 2018 is going to see low single-digit increases, at most, with the potential for another slow year in 2019. That comes after years of 5%-plus annual distribution growth.
Slow distribution growth, added to broader concerns about the midstream sector, has left Enterprise’s units down around 30% from their 2014 highs (though they are up around 9% year to date). But the reason for the slow distribution growth is important: It is intended to free up cash that can be used to self-fund capital investments. That, in turn, will reduce the need to issue dilutive new units and lower conservatively run Enterprise’s cost of capital over time. The goal is to increase retained cash flow by 70% between 2017 and 2019, allowing the partnership to self-fund around 50% of its capital spending.
Once Enterprise has worked through this transition, it will have shifted to a new self-funding business model. Which should, in turn, allow it to return distribution growth back into the mid-single-digit range as future projects bear fruit. Which suggests that the partnership’s notable 6.4% yield is a buying opportunity for patient income investors. Only don’t wait too long — at some point, Mr. Market will catch on to the opportunity.
A cheap, high-yield stock with ample growth ahead
Matt DiLallo (Enbridge): Canadian energy infrastructure giant Enbridge offers investors a little bit of everything right now. Those looking for value will find a stock that trades at just nine times cash flow, well below the peer-group average of around 12 times. Because of that cheap price, income seekers can lock in an attractive 6.8%-yielding dividend.
And those seeking growth won’t be disappointed, since Enbridge expects cash flow to increase at a 10% annual pace through 2020, which should support dividend growth at that same rate.
Enbridge backs its dividend with very stable cash flow, since 95% comes from fee-based contracts, and it only pays out about 65% of that money each year, a conservative rate for a pipeline company. Meanwhile, the company supports its growth view with 22 billion Canadian dollars ($17 billion) in high-return expansion projects currently under construction.
Despite those positives, one reason Enbridge’s stock is cheap is due to worries about its elevated debt level. However, the company has been working to alleviate those concerns by selling some non-core assets to help bridge the gap between cash flow and its capital needs, and it could sell others to provide an additional boost. Meanwhile, the company recently took steps to address another concern by offering to acquire all its sponsored vehicles. The move would simplify its corporate structure, improve its credit profile, and provide more cash flow to fund growth projects.
With its financial concerns starting to fade, now looks like a great time to buy this stock, especially since investors are getting healthy growth and income for a value price.
A high-payoff turnaround in offshore drilling
Tyler Crowe (Transocean): I can’t say with 100% certainty that we are going to see oil prices continue to rise from the current Brent price of around $75 a barrel. But not all investments in the oil and gas industry have to be completely predicated on rising prices. In fact, there are a lot of compelling reasons that offshore rig owner Transocean could be a compelling investment even at today’s prices.
While shale drillers have been going bonkers in the U.S., investment in exploration and development across the world has been incredibly low over the past several years. And the lack of investment is starting to show. The amount of production-capacity additions slated to come online between 2019 and 2022 is less than half the rate that we saw from 2015 to 2018. That lack of capacity means that producers are going to have to find new sources and develop them quickly. Even more concerning is that the amount of oil discovered in 2016 was at the lowest level in over 70 years.
All this pent-up demand means that producers will likely start to spend significantly on exploration, and no offshore rig company is better positioned to handle that demand than Transocean. It has the combination of new, highly capable rigs waiting for work to capture significant upside, while having enough contracted work and a strong-enough balance sheet to see it through these last few innings of a tough market.
Companies will need to start spending more on developing new sources. Offshore oil and Transocean are likely going to play a big role in finding and developing those new sources. So if investors want to take a flier on a stock with a lot of potential that is trading at less than half its tangible book value, take a look at Transocean.
10 stocks we like better than Transocean
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Matthew DiLallo owns shares of Enbridge and Enterprise Products Partners. Reuben Gregg Brewer has no position in any of the stocks mentioned. Tyler Crowe owns shares of Enterprise Products Partners. The Motley Fool owns shares of Enbridge. The Motley Fool has a disclosure policy.