Energy stocks were in the crosshairs of this pandemic. Demand for oil and gas crashed amidst the lockdowns and restrictions. Oil and gas prices plummeted, as did energy stocks. The arrival of vaccines, significant inflation and conflict in Europe has changed all of that. While cheap energy stocks are increasingly harder to find, there are still energy companies trading below pre-pandemic highs.
While the S&P 500 had recovered and eclipsed the pre-pandemic high by summer of 2020, energy stocks continued to wallow in bear market oblivion. The Energy Select Sector SPDR Fund (XLE), which tracks an index of energy stocks on the S&P 500, was still down more than 50% from the pre-pandemic level by the end of October 2020. Then came the vaccine.
The announcement of the first vaccine in early November that year changed everything. The vaccine promised to end the lockdowns and remove the economic shackles, unleashing a full recovery and booming economy in 2021. Cyclical or real economy stocks rallied like crazy. The XLE soared a remarkable 86% between late October 2020 and the beginning of March 2021. Then, the arrival of Delta and Omicron kept energy in a range until war in Ukraine and persistent inflation triggered a late-2021/early-2022 breakout.
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Despite the furious energy rally, the XLE is trading just above pre-pandemic prices. And you can still find a handful of cheap energy stocks still below pre-pandemic levels. But here’s the thing: The environment for energy stocks stunk before the pandemic. The high-growth environment in the coming months and ongoing supply tightness should deliver much higher profits.
Although it’s true that energy is the best performing market sector YTD, the industry is climbing out of such a low level that many stocks are still cheap. Current valuations and yields combined with powerful growth in the months ahead make energy stocks attractive.
Here are three good ones.
Cheap Energy Stock #1: ONEOK Inc. (OKE)
Yield 6.9%
ONEOK is a large U.S. midstream energy company specializing in natural gas. It owns one of the nation’s premier natural gas liquids (NGLs) systems connecting NGL supply in the Rocky Mountains, midcontinent and Permian regions in key market centers, and also has an extensive network of natural gas gathering, processing, storage and transportation assets. A whopping 10% of U.S. natural gas production uses ONEOK’s infrastructure.
The market performance has reflected the high quality, at least it did before the pandemic. In the 10 years prior to the pandemic OKE returned 427% and returned over 100% in the five years prior. Both were nearly double the market returns over the same period. But OKE fell more than 75% in the bear market. OKE is down another 10% so far this year, falling sharply after a big run in the first four months of 2022. Now it trades at a mere 13x forward earnings estimates.
That’s a bargain because, despite the challenges of the pandemic, ONEOK grew earnings 6% in 2020. It followed that up with 93% year-over-year earnings growth in 2021, and expects another 17% EPS growth this year. Given those numbers, OKE is bound to regain its footing soon.
Cheap Energy Stock #2: Enterprise Product Partners (EPD)
Yield 7.7%
Enterprise is one of the largest midstream energy companies in the country, with a vast portfolio of service assets connected to the heart of American energy production. It is connected to every major U.S. shale basin as well as 90% of American refiners east of the Rockies and offers export facilities in the Gulf of Mexico.
The key to remember is that it’s a fee business that collects tolls for oil and gas moving around the country and has very little exposure to volatile commodity prices. As a result, earnings were remarkably resilient during the pandemic. But the stock got thrown out along with the bathwater anyway.
EPD has lagged most energy stocks during this year’s rally because profits aren’t rebounding as quickly as companies with more commodity price exposure. But earnings never fell as much as most energy stocks. The stock is clearly moving the right way. It also pays a massive yield that’s extremely safe. Even in one of the toughest years ever for the industry, Enterprise still covered the distribution by 1.6 times with distributable cash flow. That’s about as good as it gets in this industry.
The stock is cheap (15% below pre-pandemic levels) and rising but it still hasn’t gotten ahead of itself. It’s still a great time to buy this stock. You can earn a massive yield on a stock that is very likely to continually appreciate over the course of the year.
Cheap Energy Stock #3: Valero Energy (VLO)
Yield 3.5%
Valero is the largest petroleum refiner in the U.S. It has 15 petroleum refineries and markets products in 43 states, Canada and the U.K. It is also one of the largest producers of ethanol and has a rapidly growing renewable diesel business.
It is the best refiner because it is the most technologically advanced and has some of highest and most resilient profit margins in the business. But none of that is the main story for this stock right now. It’s all about the recovery. Refiners are extremely cyclical. And Valero is a high-leverage play on a full economic recovery.
As demand for gasoline and diesel crashed during the pandemic, VLO got crushed. In late October 2020, VLO was down 50% from the pre-pandemic high and 70% from the all-time high. But things have reversed in a big way. Since the vaccine announcement in November of that year, the stock is up more than 190%.
The significant run-up in energy has pushed shares over the pre-pandemic high, but VLO is still trading 6% below all-time highs set in 2018. While VLO isn’t a cheap energy stock by most metrics, the emphasis on domestic energy self-sufficiency and great momentum in VLO likely sets it up for more upside.
If you want to know what other dividend-paying stocks I’m currently recommending, you can subscribe to my Cabot Dividend Investor advisory by clicking here.
Do you own any energy stocks in your portfolio right now? How have they performed? Tell us about them in the comments below!
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*This post has been updated from an original version, published in 2019.
