Refined energy investing

October 26, 2015 01:00 PM

The dramatic drop in crude oil prices caught most investors by surprise. How long prices have stayed down was yet a second shock. It begs the question: Is it finally time to invest in energy stocks?

Our indicators still say no to the vast majority of them because their earnings prospects keep getting chopped down. That is especially true for the oil exploration and production companies given that they levered up to take advantage of an oil boom that has fizzled out.  Now many are drowning in debt. 

Interestingly, there is one group in the energy space that is excelling right now: the oil refiners and marketers that currently have a Zacks Industry Rank of 24, which puts it in the top 10% of all industries. 

History shows that this group goes through extended cyclical swings. Right now that is to the upside with many of the firms seeing a tremendous run up in their earnings prospects which tips the odds in favor of stock ownership.

Now let’s review three of the best stocks in the group that Zacks currently has as “buy” rated. 

Valero Energy (VLO): At a $29 billion market cap these guys are considered the bellwether of the group. They are riding a string of eight straight earnings beats, including a solid +10% showing last quarter. This is likely the safest pick in the group given their strong track record. Plus their 2.7% dividend yield also helps pad the total return story. 

Hollyfrontier (HFC): This is more of a turnaround story as this company has missed estimates in seven of the last 11 quarters. However, the two most recent earnings reports were solid beats, which gives a glimmer of hope that things will keep getting better from here. The Zacks Growth Style Score of an “A” also gives the sense that the fundamentals are aligned for more good things to come. 

Alon USA Energy (ALJ): This refiner is concentrated in some of the better U.S. growth markets in the South and Southwest. Their 58% earnings beat for Q2 put everyone on notice that business is very good. With that, earnings estimates spiked higher as did the share price. Yet, not everyone has taken notice given their Value Style Score of an “A”. They are a fraction of the size of the other two which increases the risk of this stock. Yet if they continue pumping out earnings beats like Q2, then there will be ample reward. 

One of these days the rest of the oil patch will be a good investment. Yet far too many jumped in early on this one only to get burned. Your best bet is to be patient and wait for a sustained increase in energy prices. That will be the key to higher profits and share prices. Until then, keep your energy investments concentrated on the refiners.

About the Author

Steve Reitmeister is the executive vice president at Zacks Investment Research at zacks.com. The cornerstone of the firm is the Zacks Rank stock rating system and its 26% average annual return since 1988. These results have been examined and attested to by the independent accounting firm Baker Tilley. @ZacksResearch