EC The Top 10 Oil Stocks For Rising Oil Prices

Still, with the 4.7% dividend and 17.4% expected annual earnings-per-share growth, Exxon is likely to offer a 13.0% average annual return over the next five years.

Top Oil Stock #5: Royal Dutch Shell (RDS-A)

Royal Dutch Shell is the second-largest oil and gas company in the world, behind only Exxon Mobil in terms of annual production volumes.

During the downturn of the energy sector, which lasted from 2014 to 2017, Shell acquired BG Group, a deep-water oil and natural gas upstream company for $53 billion. Thanks to that acquisition, Shell boosted its production to 3.8 million barrels per day.

However, due to the extensive asset sales that helped fund the acquisition, the output has remained essentially flat in the last two years. This is in sharp contrast to the trend observed among the other oil majors, which are growing their output at a decent pace.

On the other hand, during the recent downturn, Shell drastically reduced its operating expenses and fine-tuned its portfolio by investing in high-quality, low-cost reserves. As a result, the oil giant has become much more profitable than in the past at a given oil price.

Source: Investor Presentation

To provide a perspective, in 2018, Shell posted record organic free cash flows of $31 billion even though the average price of Brent was 40% lower than it was before the downturn.

Although Shell has frozen its dividend for four consecutive years, it still has an impressive dividend record, as it has not cut its dividend since World War II. In addition, the stock offers an exceptional 6.4% dividend yield.

It is also remarkable that Shell exceeded Exxon in annual operating cash flows in 2017 for the first time in about 20 years and maintained its top position last year. The company expects its annual free cash flows to remain around $30 billion over the next three years. As this amount is twice as much as the dividend, the dividend can be considered safe for the foreseeable future.

Shell is trading at a price-to-earnings ratio of 12.0, which is equal to our assumed fair earnings multiple. Therefore, given the 6.4% dividend and 8.2% expected annual earnings-per-share growth, Shell is likely to offer a 14.6% average annual return over the next five years.

Top Oil Stock #4: Total (TOT)

Total is the fourth-largest oil and gas company in the world based on market cap. It is the most diversified and integrated oil major, making it the most defensive stock during downturns. This was evident in the recent fierce 2014-2016 downturn of the energy sector, when the earnings per share of Total fell only 49% whereas those of Exxon slumped 75% and Chevron and BP posted losses in 2016.

On the other hand, the integrated structure of Total means that it benefits less than its peers when the price of oil rallies. Of course, higher oil prices boost the earnings of Total but the investors who have strong confidence in higher future oil prices will be better served by investing in the other oil majors, such as Chevron and BP, which are more leveraged to the oil price.

That said, Total will still benefit from higher oil prices because it has returned to growth mode in the last few years. The company grew its production by 8% last year and is poised to grow its output by 9% this year. It also expects to grow its production by 5% per year for at least the next three years. We expect Total to grow its earnings per share by 7.0% per year on average over the next five years.

In addition, Total has greatly improved its asset portfolio since 2015. During this period, Total has added about 7.0 billion barrels of reserves at a cost below $2.5 per barrel and expects free cash flows above $4.0 billion from these assets this year.

Source: Investor Presentation

As Total posted free cash flows of $12.1 billion last year, it is evident that the above assets will boost the free cash flows by about one-third.

Total does not have the impressive dividend record that Exxon and Chevron have but it offers a superior 5.5% dividend yield. This yield is lower than the yield of Shell and BP but Total is much more defensive than its peers during downturns and has much brighter growth prospects than Shell. Overall, Total offers a better combination of yield, growth prospects and resilience in downturns than the other oil majors, though it is not the best oil major to own during a rally of the oil price.

Total is trading at a price-to-earnings ratio of 10.2, which is lower than its 10-year average earnings multiple of 11.9. If the stock reverts to its average valuation level over the next five years, it will enjoy a 3.1% annualized boost in its returns. Therefore, with the 5.5% dividend and 7.0% expected annual earnings-per-share growth, Total is likely to offer a 15.6% average annual return over the next five years.

Top Oil Stock #3: Schlumberger (SLB)

Schlumberger is the world’s leading provider of oilfield services and technology, with activity in more than 120 countries.

While the energy sector has been slowly recovering from the 2014-2016 industry downturn, Schlumberger’s recovery has been disappointing so far, primarily due to two headwinds. First of all, shale oil producers have become conservative in their budgets and thus they have reduced their investment spending, in order to avoid growing their debt load.

In addition, there has been great technological progress in oil production in recent years. As a result, oil producers are now able to extract more oil from a given number of wells. It is impressive that global investment in oil production is still 40% lower than it was in 2014, just before the downturn of the sector, whereas oil production has grown 7% since then.

Source: Investor Presentation

This striking divergence shows that oilfield service providers have incurred permanent deterioration in their business, as they generate lower revenues at a given oil production level. In other words, these companies have become victims of their own success. Due to this secular change, the market has punished Schlumberger to the extreme, by sending the stock to a 10-year low.

Schlumberger is offering an almost all-time high dividend yield of 5.2%. Due to its suppressed expected earnings per share of $1.50 this year, the stock is trading at a price-to-earnings ratio of 25.3, which is much higher than our assumed fair earnings multiple of 20.0. If the stock reaches our fair valuation level over the next five years, it will incur a 4.6% annualized drag to its returns.

On the other hand, due to its suppressed earnings per share this year, we expect the company to grow its bottom line from $1.50 this year to $3.20 in 2024 for a 15.5% average annual growth rate, primarily thanks to the sustained boom in U.S. oil production. We thus expect the stock to offer a 16.1% average annual return over the next five years.

Top Oil Stock #2: Occidental Petroleum (OXY)

Occidental Petroleum is an oil and gas producer with operations in the U.S., the Middle East and Latin America. While it also has a midstream and a chemical segment, it should be viewed as an essentially pure upstream company. It is thus much more leveraged to the oil price than the well-known oil majors.

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