In 2014, commodities and oil & gas sold off, and the related stocks underperformed the market. A slowing global outlook, largely in Europe and developing economies, and increasing supply in both sectors compounded to cause the selloffs. Oil prices are just over $50/bbl currently compared to over $100 for most of the past three years, see the following chart. Long-term we expect the global economy to recover and cause demand to rebound for oil & gas and commodities. Many industry analyst still expect long-term oil prices of around $80/bbl.
While the timing of a recovery in the global outlook and commodity prices is hard to time, we believe that there are some good long-term value stocks created by the selloff. We like Phillips 66 and Kinder Morgan in oil & gas. Forecasts are for both to have strong earnings and dividend growth over the next five years, and they can do so regardless of the price of oil.
For BHP Billiton, it is the best of breed miner, and we see increases in the currently muted outlook for long-term global commodity consumption as the catalyst in 2015. We expect developing markets and a recovery in Europe would drive its share price higher.
Phillips 66 Long-term Play on U.S. O&G Production Volumes
Long-term, the fundamentals and diversity are attractive at Phillips 66 (NYSE: PSX). Given near-term uncertainty in oil prices, we view PSX as a smart way to find value in the sector with less exposure to short term oil price changes and drilling volumes. It will benefit from increasing O&G volumes in the U.S. over the next ten years. Street expectations are that earnings and dividends will continue to grow, the latter at close to a 20% CAGR through 2018.
Phillips 66’s business model is one of the most diversified among refiners. Its primary segments are Midstream, Chemicals and Refining & Marketing. The decline in oil prices over the past quarter has driven PSX and the whole sector down and created a good buying opportunity.
We expect long-term production will continue to increase in the U.S. behind ongoing development of shale projects. PSX is making further investments in the Midstream business, which transports oil & gas, and will lead to higher earnings and improving cash flows. Management issued capex guidance of $4.6 billion for 2015 compared to $4 billion in 2014 with investment in Midstream largely responsible for the increase. In addition, Goldman Sachs forecasts EBITDA in the MLP business will increase from $1.1 to $2.2 billion by 2017 behind growth in transportation, refining logistics and NGL volumes. While the Chemical segment is marginally impacted by the lower price of crude, it will adjust prices and forecasts are for the business to grow by 30% by 2017. Combined this will drive the ~20% dividend CAGR, earnings growth and the share price along with those.
Kinder Morgan Provides Good Value for 2015 and Beyond
Kinder Morgan (NYSE: KMP) is another oil & gas stock that we like for both 2015 and longer term. It should grow dividends in the double-digits for next few years. It has made some acquisitions in the MLP space that should lower its cost of capital and contribute to its dividend growth. Its recent merger also provides a $20 billion tax benefit over the next 14 years. This should improve FCF and fund the 16% dividend increase in 2015 and a 10% increase each year after that.
In addition, management noted that the merger results in a much lower cost of capital through the elimination of Incentive Distribution Rights. This can drive additional investment and acquisition at a time when there are some cheap assets in the market due to the decline in oil prices. Additional acquisitions provide upside to current earnings and dividend forecasts.
The stock has a dividend yield of 4.2% currently. Management commentary and forecasts for dividends are for grow over the next five years. The stock looks cheap, and we expect shareholders will benefit from a rising share price and dividend this year.
Petrobas (NYSE: PBR) and Gazprom (MCX: GAZP) are two other oil and gas ideas for those that look to the international markets as well.
BHP Billiton 2014 Selloff is an Opportunity to buy into Long-term Global Growth
BHP Billiton (NYSE: BHP) is the largest producer of resources in world. It is centered mostly on mining, but also does some oil & gas exploration. The pullback in demand and prices in the iron ore and copper markets caused the stock to start selling off in early July 2014. The stock is down over 33% since July 5, 2015. Two primary changes in the market contributed to the selloff, China’s economy started to stumble, especially the housing sector, and the outlook for global growth continued to soften in Europe and emerging markets. This led to declines in commodity prices and volumes which cut into BHP’s future earnings outlook.
Long-term, we expect emerging markets and Europe to rebound. China will continue to grow but may have to weather some additional pains near-term. Also countries like India will continue to increase commodity consumption. While prices may not return to prior highs for many commodities, demand will rise and with it production. For BHP Billiton this will translate to higher production and increasing earnings. Right now, the sector is out of favor but we expect global growth will improve in 2016. The share price should improve with the outlook and higher commodity prices.