There Really Is a Silver Lining Amid Oil Stocks

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With the world awash in cheap oil, analysts do not see an immediate rebound in the sentiment and expect more punishing times ahead. Therefore, one needs to have an appetite for risk in order to invest in the energy sector today. But for savvy investors, there are opportunities to earn big returns.

Standing on the threshold of 2016, if you have an appetite for 'energy' stocks in a choppy market, you ought to first screen the industries from the broader energy sector for the prized catches.

No Problem for Downstream

Investors need not fear nor steer clear of energy stocks, as there are still a handful of them that are showing strength during this shaky period. In particular, with oil prices cooling off, U.S. downstream (refining and marketing) stocks have been notching up healthy gains and earnings beats.

The business of the downstream players is negatively correlated with crude prices. This is because the companies use oil as an input from which they derive refined petroleum products like gasoline, the prime transportation fuel in the U.S. Hence, lower the oil price, higher will be their profits.

To add to this, robust demand for gasoline (the most widely used petroleum product) has lifted crack spreads and is set to provide further upside to the companies' bottom line.

Finally, in order to take advantage of the strong gasoline demand and higher margins, the companies are operating their units at record high capacity, sometimes at more than 100%. Therefore, the future looks bright indeed, for the likes of Murphy USA Inc. ( MUSA ), Phillips 66 ( PSX ), Valero Energy Corp. ( VLO ) and Western Refining Inc. ( WNR ).

Integrated Majors' Diversification Minimizes Risk

In this current turbulent market environment, we advocate the relatively low-risk energy conglomerate business structures of the large-cap integrateds, with their fortress-like balance sheets, ample free cash flows even in a low oil price environment and steady dividends.

Thanks to their integrated structures, companies like Exxon Mobil Corp. ( XOM ), Chevron Corp. ( CVX ), Royal Dutch Shell plc ( RDS.A ) are able to withstand plunging oil prices better than the rest and protect their top and bottom lines to a certain extent on downstream strength. With the refining unit of these conglomerates being buyers of crude -- whose price is in a freefall -- their profitability improves due to a fall in the input cost.

The companies' financial flexibility and strong balance sheet provide them with a larger war chest to draw upon in this highly-uncertain period for the economy. Most of them remain in excellent financial health, with ample cash on hand and investment-grade credit ratings with a manageable debt-to-capitalization ratio. On top of this, managements have established quite a track record of conservative capital management and cash returns to shareholders. They also pay a safe dividend, yielding attractive returns.

While most of them are near 52-week lows after enduring the crude carnage over the past 18 months, holding on to them can still prove to be an astute move.

MLPs: Providing Attractive Income Potential

A safer way of playing the sector would be to utilize Master Limited Partnerships (MLPs), which offer considerable returns at significantly lower risk.

Most MLPs are involved in storage, processing and transportation of energy commodities such as natural gas, crude oil, and refined products, under long-term contracts. As such, they have relatively consistent and predictable cash flows - unlike the E&P companies, whose profits are highly correlated with commodity prices.

Ramping up oil production during the past few years has caused the commodity market to enter oversupply territory. Still, there is no slowdown in the crude production as all the big players are competing for their own share. This definitely calls for storage and transportation services, especially when the analysts are expecting the oversupplied market to continue in 2016.

Given the current weaknesses in petroleum stocks, MLPs are probably the best method of investing in the sector. They also offer liquidity and tax benefits, which add to their appeal. This is why these stocks would make good additions to your portfolio.

We suggest Boardwalk Pipeline Partners L.P. ( BWP ), Energy Transfer Equity L.P. ( ETE ) and PBF Logistics L.P. ( PBFX ).

Check out our latest Oil & Gas Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy.

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EXXON MOBIL CRP (XOM): Free Stock Analysis Report

WESTERN REFING (WNR): Free Stock Analysis Report

VALERO ENERGY (VLO): Free Stock Analysis Report

ROYAL DTCH SH-A (RDS.A): Free Stock Analysis Report

PHILLIPS 66 (PSX): Free Stock Analysis Report

PBF LOGISTICS (PBFX): Free Stock Analysis Report

MURPHY USA INC (MUSA): Free Stock Analysis Report

ENERGY TRAN EQT (ETE): Free Stock Analysis Report

CHEVRON CORP (CVX): Free Stock Analysis Report

BOARDWALK PIPLN (BWP): Free Stock Analysis Report

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Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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