How to Choose the Right Energy Company
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It’s not so much about finding the best company in the energy sector -- every stock provides a particular risk and return tradeoff, and investors should focus on the one that best fits their own needs. The key is looking for the right company according to the investor's profile, strategy and visions of the world.
The evolution of energy prices will always be a main determinant of the returns of every energy producer, but that's outside a company's influence. However, oil companies have different operating structures and cost profiles, so they will be affected in different ways by the fluctuations of energy prices. According to the investor's outlook about energy prices, different companies seem more appropriate.
If you have a generally bearish view about the economy and energy prices, a good possibility would be for the safest company in the group, which is probably ExxonMobil (NYSE: XOM). Exxon is the biggest integrated oil and gas producer -- and by a wide margin -- but the company is also the most profitable of the group with a Return on Equity (ROE ratio) of almost 26%.
Exxon's defensive attributes are not only related to its size. Higher profitability means better capital allocation, and that's an important reflection on management quality. You don't get to play the energy sector more safely than with shares of Exxon, and the stock is not expensive at all yielding a 2.7% in dividends and trading at a P/E ratio barely above 10.
Those who want to play it safe but are still looking for attractive valuations and upside potential may want to take a look at Chevron (NYSE: CVX). With a ROE of 23% Chevron is barely below Exxon in profitably levels, but it's also much cheaper. Chevron is trading at a P/E ratio of 7.6 and it pays a juicy dividend yield of 3.4%. For a moderately bullish oil scenario, Chevron looks like a smart play because it combines fundamental quality and low valuations.
Those willing to go one step further on the risk scale may want to consider a company like ConocoPhillips (NYSE: COP), which is trading at very convenient valuations with a P/E ratio of 6 and a dividend yield of 4.7%. After the spin-off of its downstream business into a separate entity, Conoco is planning to get much more focused on growth opportunities, a strategy that has many chances of high returns in a bullish oil scenario.
Nobody wants anything to do with Europe nowadays, and that's probably why shares of Total (NYSE: TOT) are so cheap. This France-based company has managed to achieve an ROE ratio of almost 18%, but it still trades at a really cheap dividend yield of 6.8%. Total is a global corporation with businesses and projects all over the world, so it should do fine over the long term regardless of the volatility coming from Europe on a daily basis. Those looking for a contrarian bet with really attractive dividend yields may want to consider Total as a possibility.
Petroleo Brasileiro (NYSE: PBR), or Petrobras, is probably the one that stands to gain the most in a scenario of strong energy prices during the coming years. Petrobras has dramatically excelled its peers in terms of new discoveries and by a big distance -- in fact, the company could double its resource base and production levels in the next 10 years.
Petrobras is planning to spend $225 billion on those projects over the next five years -- a big opportunity but also a heavy financial burden. If oil prices don't help, Petrobras could have trouble developing those offshore -- and very expensive -- reservoirs. Also, government intervention is always a risk considering that the Brazilian government owns a majority voting stake in the company.
There is a big energy company for every taste and with different exposure to energy prices. Investors simply need to find the alternative that best suits their personal characteristics and investment strategy. It's not about the right stock; it’s about the right stock for each portfolio.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services recommend Chevron, Petroleo Brasileiro S.A. (ADR), and Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.