The vaccines are changing everything. The notion of ending this pandemic and unleashing a full recovery in 2021 is even bringing energy stocks back from the dead. If the vaccine can bring these sorry stocks back to life, ending the pandemic should be easy.
Since the first vaccine announcement about a month ago, the Energy Select Sector Fund (XLE) has rallied 33%. That’s a huge move for a fund of many stocks in just a month. The powerful stock market recovery had excluded energy until now. The emergence of energy as the top-performing sector is a major market rotation that is changing the game.
Energy had been by far the worst-performing sector of the market during the pandemic, down 50% YTD at the end of October. But it was also the worst-performing market sector going into the pandemic. Before anybody ever heard of the coronavirus, energy had been the worst-performing market sector for every measurable period over the past 10 years.
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The market hated energy stocks for a reason. The massive new supply of oil and gas produced by the American energy revolution caused an oversupply and a crash in global energy prices. As a result, the profitability of many energy companies suffered. That situation will still persist long after this pandemic becomes nothing but an unpleasant memory.
And there’s something else. Fossil fuels are dirty and increasingly archaic. Alternative or clean energy is the wave of the future. The clock is ticking on the death of fossil fuels.
The market loves alternative energy and hates oil and gas. Just look at the performance of alternative energy companies like Tesla (TSLA). To the market, clean energy will inherit the future and fossil fuels are becoming a relic of the past.
That said, oil and gas aren’t going out of style any time soon. Fossil fuels still account for about 80% of U.S. energy consumption, and a higher percentage than that in the rest of the world. The full recovery, already being priced in by the market, cannot occur without a sizable increase in demand for oil and gas, and increasing profitability for energy companies.
Sure, oversupply problems may persist after the pandemic. And oil and gas will increasingly lose market share to clean energy. But consider this: The XLE will need a 50% upside move from here to just get back to where it was right before the pandemic. And things stunk then.
Energy stocks have a long way to go before the aforementioned problems start limiting their ascent. Just a move out of the industry’s depression should bring outsized returns for many energy stocks in the months ahead. Meanwhile, these stocks are cheap in an expensive market. Several pay massive dividends. And now they finally have momentum.
Here are two undervalued energy stocks worth considering.
Undervalued Energy Stock #1: Chevron (CVX)
Chevron is one of the world’s largest integrated energy companies, with operations throughout the world. The company is involved in every facet of the energy industry but it is heavily skewed toward the upstream segment, oil and gas production and exploration. It has a huge and growing presence in the Permian basin, the largest shale oil producing region in the U.S. and the fastest growing oil region in the world.
Chevron likely won’t be the most profitable energy stock to own going forward. But it is one of the safest. The company entered the recession in better shape than its peers. It already completed big projects and had cut back on new spending. It did a great job getting lean and mean in the last few years and has peer-leading low costs.
Chevron doesn’t need a high bar to be profitable and can likely turn things around very quickly as the economy improves. It also pays a 5.75% dividend yield that will be maintained and grown. The market seems to agree with all this. The stock has outperformed all its large energy company peers in the sector recovery, and is up 30% in the last month. CVX stock also needs another 33% upside just to bet back to where it was at the beginning of the year.
Undervalued Energy Stock #2: Valero Energy (VLO)
Valero is one of the largest petroleum refiners in the country and by far the most cost effective and technologically advanced. It also has a large renewable diesel business that should grow very quickly. It is the best player in an industry that has been in the doghouse all pandemic.
Refining is a cyclical business. This is a far more gun-slinging choice than Chevron. You don’t want to own a refiner in a recession. You want it coming out of a recession. Demand for refined products (gasoline, diesel, jet fuel, heating oil) fell off a cliff during the lockdowns. Most of the demand has returned, but not all. The industry also had a huge built-up inventory to work off. But it’s getting there.
It’s simple. There can be no full recovery without gasoline and diesel. Refined products aren’t going out of style any time soon. If the recovery that the market is already factoring in comes to fruition, fortunes and profits for Valero must recover with it.
The stock is up over 50% in the past month. But it is still 67% below where it was before the pandemic. VLO is now a high leverage play on the vaccines and a full recovery. It also pays a massive 6.8% yield. And the company’s CFO called maintaining the dividend “the number one financial priority.”
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