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  1. Home
  2. / Investing
  3. / Energy

How to Play Oil's Big Rebound

Crude has been rising since last June, and here are the names that I like here.
By TIMOTHY COLLINS
May 11, 2018 | 08:30 AM EDT
Stocks quotes in this article: RDS.A, TOT, E, STO, SNP, XOM, PSX, VLO, HFC, ETE, WLL, PBR, RIG, BHGE, SLB, HAL, NOV

Oil has been on a constant march higher since bottoming out last June. With summer-driving season around the corner, the price has to head even higher from here, right? Not necessarily.

In fact, that hasn't been the case over the last few years. Rather, West Texas Intermediate crude has headed lower beginning in June every year since 2014. You might even recall that 2014 was particularly brutal for oil, which lost more than half of its value during the year's second half.

So, I'm approaching oil-company stocks with caution here. In addition to the concerns noted above, we have to worry about the U.S. dollar. What impact will it have on the bottom line? Revenue is great, but what a company can use it for or keep is more important.

Let's check out some individual oil sectors and names:

International Oil Majors

While you're probably alright putting your money in a large U.S. oil name like ExxonMobil (XOM) given its 4% dividend yield, XOM's long-running underperformance vs. the S&P 500 worries me a bit. After all, the market hasn't yet experienced much rotation into underperformers. Winners continue to get all of the attention while losers stay in the time-out corner

Add in my concerns about the dollar and rising domestic interest rates and I'm warming up more toward some U.S.-listed foreign oil names like Royal Dutch Shell (RDS.A) , France's Total (TOT) , Italy's Eni (E) and Norway's Statoil (STO) . I might even give China Petroleum & Chemical Corp. (SNP) some consideration here.

The only major problem here involves dividends. ExxonMobil offers a solid dividend yield with little risk of that coming down. By contrast, Royal Dutch Shell currently boasts a better dividend yield -- 5% -- but a high payout ratio, which measures how much net income a firm must use to cover its dividend payments. A high payout ratio is risky, as RDS.A could have to cut its distribution if there's ever any hiccup in its business.

So, Total might represent the best mix here. It combines a generous 4.65% dividend yield and a payout ratio that's higher than Exxon Mobil's but lower than Royal Dutch Shell's. And Eni registers as the safest of the bunch, with a payout ratio that's half of XOM's despite a nice 3.25% dividend yield.

China Petroleum also often offers the highest distribution, but it's a bit of a guessing game whether SNP will pay a 6%+ yield or something under 4%. SNP's payout ratio was 118% last year, and the anticipated May 24th dividend sits at $4.57. But what we've seen from China Petroleum in the past and what we get in the present are often two very different things.

That said, SNP often follows its May payout with a September dividend. So if you're a yield player with a bend toward slightly more aggressive oil exposure, China Petroleum might be for you.

But personally, I prefer investing in a mix of Royal Dutch Shell, Total, SNP and Eni. That offers an anticipated net yield greater than XOM at a similar payout ratio, but with the benefit of investment diversity.

Forget the Oil Refiners

Refiners like Phillips 66 (PSX) , Valero Energy (VLO) , and HollyFrontier Corp. (HFC) are already so extended that they've become an impossible chase. We're talking +15-20% year to date and up 50% from this time last year.

I'd rather dive into a master limited partnership like Energy Transfer Equity (ETE) . ETE's yield is pushing toward 7.5%, and we already have earnings out of the way. And from a performance standpoint, MLPs have done little year to date, so they offer a reinvest-yield thesis while prices are depressed.

Skip Most Explorers, Too

It's a similar story with oil explorers -- Whiting (WLL) , Petrobras (PBR) , and Transocean (RIG) have already snagged all of the momentum.

I'd rather lean toward Diamond Offshore Drilling DO, which is one of the few names sitting at resistance right now rather than having broken well above it. I suspect we'll see that break through eventually.

That being said, RIG doesn't look too far extended. I'd either buy DO on a breakout or wait for the group to pull back.

However, I expect this group to get hit the hardest If oil lags in June. With nothing in the way of yield, it's all about capital appreciation -- and oil prices -- here. Unfortunately, I simply don't have enough confidence to buy.

So, a name like Baker Hughes General Electric (BHGE) is where I'd turn. BHGE's 2% dividend yield won't turn heads, but the company combines little debt with a price-to-earnings ratio similar to better-known oil names like Schlumberger (SLB) or Halliburton (HAL) . And if National Oilwell Varco (NOV) ever ups its distribution, I'd turn more attention its way as well.

The Bottom Line

If you haven't jumped on the oil bandwagon yet, you're late to the party -- very late.

I'd enter any stock cautiously here -- not committing to a full position, but maybe just a one-quarter position to start. Then, watch for retests of previous breakout levels or an oil retracement in the neighborhood of 10% to 15% before getting to a larger position.

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TAGS: Investing | U.S. Equity | Energy | Industrials | Stocks

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