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Where to Find Bargains Among Oil and Natural-Gas Stocks

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Investors have been shaken by concerns that demand for oil and natural gas will weaken as global growth slows and the use of renewable energy sources increases. Yet those worries may be overblown. And the shares of many energy companies look attractive after a recent 15% retreat in the sector.

The key has been a shareholder-friendly approach. Energy companies have shown greater financial discipline by reining in capital spending and returning more cash to shareholders.

Four of the big integrated energy companies—
BP

(ticker: BP),
Chevron

(CVX),
Exxon Mobil

(XOM), and
Royal Dutch Shell

(RDS.A)—have dividend yields in the 4% to 6% range and can probably cover them from earnings, even if Brent crude, now around $67 a barrel, drops closer to $50.

U.S. energy producers like
EOG Resources

(EOG) are capitalizing on drilling opportunities in the low-cost Permian Basin, and out-of-favor natural-gas producers like
Cabot Oil & Gas

(COG) and
EQT

(EQT) offer a play on the strengthening gas market. U.S. natural-gas prices have rallied $1 recently, to $4 per million British thermal units, thanks to a combination of low gas storage ahead of the winter heating season and cold weather in the eastern half of the country.

“If the economy is as weak as what’s being discounted in energy stocks, investors have bigger problems in their portfolios,” says Doug Terreson, an energy analyst with Evercore ISI.

Power Up

Here are some energy stocks that investors may want to consider.

E=Estimate

Source: Bloomberg

He is bullish on BP and Royal Dutch Shell. At $41, BP trades for 12 times projected 2018 earnings and yields 6%, and Royal Dutch’s Class A shares, at about $61, trade for 11 times estimated 2018 profits and yield 6%. The dividend on the Royal Dutch Class A shares is subject to U.S. withholding taxes, but investors usually can get a credit for that levy on their tax returns.
Royal Dutch’s Class B shares

(RDS.B), at $63, aren’t subject to the dividend withholding tax.

Chevron is benefiting from rising production and reduced capital spending as big projects like two giant liquefied-natural-gas plants in Australia have increased output in the past year. It also has one of the best positions in the Permian Basin of Texas and New Mexico—a prolific oil-and-gas producing region—and could double its output there in the next three years. At $117, Chevron trades for 14 times estimated 2018 earnings of $8.41 a share and yields 3.8%.

Credit Suisse analyst William Featherston upgraded Chevron to Outperform from Neutral earlier this month and set a price target of $138, citing “continued execution, free-cash-flow visibility, and compelling valuation.” He sees 7% production growth in 2018 and 2019, enabling the company to generate $10 billion of free cash flow after dividends next year. Chevron resumed stock buybacks in the third quarter and is targeting a modest $3 billion in repurchases annually, about 1.5% of its market value.

Exxon Mobil is starting to regain investor confidence after a series of quarterly earnings and production shortfalls. At $78, its shares trade for 16 times projected 2018 earnings and yield 4.2%. Barron’s wrote favorably on Exxon in May, when the stock traded around its current level.

EOG Resources

(EOG) and
Occidental Petroleum

(OXY) appeal to Mark Stoeckle, the senior portfolio manager at the Adams Funds. He says Occidental, whose shares trade around $72, should be able to maintain its dividend, now providing a 4.3% yield, even if West Texas crude trades down to $50 a barrel. EOG is viewed as one of the best managed exploration-and-production companies, with a strong Permian position that allows it to drill profitable wells even with oil prices in the $40s.

The Adams Natural Resources fund (PEO), a $500 million closed-end fund, trades at $17.50, a wide 17% discount to its net asset value, and yields 3.8%.

U.S. natural-gas stocks have received a lift from stronger commodity prices but are generally lower year to date.

EQT, one of the country’s largest gas producers, has suffered from operational problems and from rumored sales by hedge funds. EQT had some of the highest percentage ownership by hedge funds at the end of the third quarter and was considered a “hedge fund hotel.”

With the selling pressure, EQT shares are down to $17, a decline of 44% this year. Bulls argue that the shares look appealing, trading for about four times projected 2019 earnings before interest, taxes, depreciation, and amortization, or Ebitda, a discount to Cabot, which is valued at about eight times.

A modest increase in EQT’s Ebitda valuation could result in a large increase in its stock price, given moderate leverage.

Write to Andrew Bary at andrew.bary@barrons.com

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