A build-up in global oil inventories led the Organization of Petroleum Exporting Countries (OPEC) to agree to cut its daily oil production beginning in January 2017. As a result, oil prices are showing strength this year, as are energy stocks. However, a surge in U.S. oil production has led to this week’s announcement that OPEC will continue cutting production through March 2018, in order to meet global inventory targets. Production cuts have been helping oil prices, and have not been hurting revenue at global integrated oil companies, which all have tremendous multi-year profit outlooks. As a result, one major oil company in particular looks like a highly undervalued energy stock at the moment.
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At present, I feature three oil companies in my premium Cabot Undervalued Stocks Advisor portfolio. But there’s a fourth undervalued energy stock that I also love! The reason it’s not in my portfolio (yet) is that I’m simply overweight in energy stocks, and don’t dare add another. But I’m happy to tell you about this great company today.
Undervalued Energy Stock Has a Familiar Name
The company is Chevron (CVX). It’s a U.S. integrated oil company, in the business of energy exploration, production, storage, refining, marketing and petrochemicals. As with most energy stocks, Chevron’s net income fell in 2015 and 2016 when oil prices plummeted. Now that oil prices are recovering, the rebound in profits is eye-popping!
Chevron reported adjusted earnings per share of $0.94 in 2016; a low number, but still profitable. Many other energy companies suffered losses that year! The consensus estimate among Wall Street analysts is that Chevron will likely earn $4.46 and $5.85 per share in 2017 and 2018 (December year-end). That represents huge earnings growth this year, and another 31.2% earnings growth next year! For comparison, it’s quite normal for large American corporations to grow their profits at annual rates of zero to ten percent. Therefore, professional investors are standing up and taking notice of Chevron’s growth trajectory.
Earnings growth doesn’t tell us anything about valuation. For that number, we look at the price/earnings ratio (P/E). I prefer for the P/E to be distinctly lower than the earnings growth rate. When the share price eventually rises, I usually won’t consider the stock to be fairly valued until the P/E is equal to the earnings growth rate. Keeping in mind that Chevron is tripling its profits this year, and probably growing them at about a 31% pace next year, the corresponding P/E’s are just 23.8 and 18.2 right now. Wow, that’s one undervalued growth stock!
But wait, there’s more! Chevron also pays shareholders a big quarterly dividend with an annual yield of 4.1%. Not only do big dividends boost the total return on your investment, they also serve to help limit the downside on the stock during market corrections. That’s because investors are far more hesitant to panic and sell stocks that are paying them attractive quarterly income. Less selling means less downward pressure on share prices.
It’s also worth noting that despite the downturn in profits during the recent season of plummeting oil prices, Chevron did not cut its dividend payout. The company ultimately delivered shareholders another dividend increase last fall.
Another important number that I always assess is the long-term debt-to-capitalization ratio. I like that number to be lower than 40%. I want to know that the company has enough financial flexibility to take care of its existing financial commitments, and venture into new business areas, repurchase stock and hire employees as it sees fit. A company can’t do that when it’s strangled by debt repayments. Fortunately, Chevron’s December 2016 debt ratio was quite low at 18.7%.
CVX Showing Signs of Life
Chevron is a large-cap stock, with a market cap of $200 billion. Its share price suffered greatly in 2015, then rose about 50% in 2016, retracing the recent highs from 2014. Stocks don’t generally rise 50% in a short time period without having a subsequent pullback, and that’s exactly what we’ve seen with CVX and its peers in 2017. The share price recently declined and stabilized over a four-month time period, and now appears ready to rise again. This is the perfect time to buy shares of an aggressively growing, undervalued energy stock!
I don’t think we’re going to see another pullback in CVX. I expect the share price to rise immediately, especially in light of this week’s OPEC announcement. There’s some upside price resistance at 116, where the stock will likely rest before continuing its upward climb.
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