Top Picks For Buying Energy Stocks On The Dip

Despite a recent drop in oil prices, the energy sector ranked second on the S&P 500 last week, with investors flocking back into the stocks amid a turnaround in investor sentiment.

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Oil prices remain near their Dec. 2021 lows, despite last week's rebound in the sector. Would now be a good time to buy selected stocks at a discount?

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According to Thummel, investors may find companies that pay high dividends and generate a lot of free cash flow attractive.

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He highlighted Chevron as a company with an attractive dividend yield as one of his top picks.

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Located in the southwest United States, the Permian Basin is growing oil production, and Tortoise Capital's senior portfolio manager believes the company will "lead the way" in meeting global energy demand and decarbonization requirements.

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Besides Cheniere Energy and Energy Transfer, Thummel also likes two stocks in the energy infrastructure sector.

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As a result of its decades-long contracted cash flow, Cheniere generates lots of cash in the short term and will continue to do so for a long time to come. Additionally, the company has an aggressive stock buyback program and a free cash flow yield of more than 10%, he said.

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Energy Transfer has a dividend yield of over 10% and "significant" free cash flow, Thummel said.

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Oil markets are the focus of the fund manager's investment strategy.

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He told Trade Algo that there has been under-investment in oil markets. "This will just make it more difficult for supply to keep up over the long run," he said.

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By 2023, Thummel expects a record high for global oil demand, while oil prices will rise to between $80 and $90 a barrel the following year - even if there is a recession.

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Playing oil differently

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The energy sector is a different story for fund manager James Davolos. He likes Viper Energy Partners, a company with a portfolio of oilfield royalty investments.

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Mining and exploration projects are typically funded by royalty companies in exchange for a slice of production revenue or a contractual quantity.

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According to Viper Energy, the basin's [Permian] backlog is among the largest in the world. Diamondback [Energy], their parent company, is probably one of the best independent operators out there. Davolos, portfolio manager at Horizon Kinetics, wrote in notes to Trade Algo on Monday about an operator that self-funds production at the highest quality acreage and sponsors royalty cash flow growth.

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In contrast, Viper Energy, which has only administrative costs associated with royalties, has a breakeven in the "low, single digits" as Diamondback's breakeven maybe $50 to $55 a barrel. Davolos believes Viper Energy has a “strong” downside support that enables it to take advantage of improving energy prices while leveraging an improvement in energy prices.  

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Morgan Stanley and Goldman's energy picks

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Recent energy picks have also been shared by a host of investment banks.

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Exxon and Enterprise Products Partners are recommended as defensive plays through Goldman Sachs within the midstream sector, which involves companies that process and store oil and gas.

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The Securities and Exchange Commission said last week that Morgan Stanley had "overweighted" TotalEnergies shares on the basis of its "significant" growth prospects, strong balance sheet, and "ambitious plan" for its energy conversion.