The energy sector was among the worst-performing sectors in 2020. The Energy Select Sector SPDR Fund (XLE) fell sharply during the year. However, energy stocks have looked strong in 2021 amid the rise in crude oil prices. What are the best energy stocks that can deliver good returns in 2021?
For commodity producers, including those in the oil and gas industry, the commodity price environment tends to be a bigger driver of stock prices than company-specific sectors. Therefore, before identifying good energy stocks to buy in 2021, we should first look at the outlook for crude oil prices.
Energy prices in 2020
Energy prices have come a long way since April 2020 when the WTI contract turned negative for the first time in history. The outlook for energy prices eventually boils down to the demand-supply dynamics. In the short to medium term, the demand-supply scenario is looking reasonably good.
From the demand perspective, as the economic recovery gains momentum in 2021, it would lift the demand for crude oil. The supply side is also looking supportive. In January, Saudi Arabia announced a unilateral production cut after years of chasing market share even at the cost of pulling down crude oil prices.
Biden’s policies will impact crude oil prices
President Biden’s policies will impact crude oil in several ways. First, if the administration clamps down on new shale projects, it would benefit crude oil prices. However, the administration is also looking to replace ICE (internal combustion engine) cars with electric cars, which would lead to long-term demand destruction. Finally, if Iran resumes oil exports under the Biden administration, it would add to the crude oil supply and more than offset the Saudi production cut.
OPEC+ should be very pleased with the Biden admin’s announcement of its intention to ban oil production on federal lands. That could cut #oil production in the US by 4%, push oil prices up, eliminate competition from small firms, etc. Saudi Arabia & Russia like this a lot. #OOTT— Ellen R. Wald Ph.D.🛢 (@EnergzdEconomy) January 21, 2021
Best energy stocks — ExxonMobil (XOM) versus BP (BP)
Both ExxonMobil and BP are integrated oil companies with global operations. XOM stock has lost 30.6 percent over the last year and 40.8 percent over the last five years. BP has lost almost 36 percent over the last year and 2.9 percent over the last five years. XLE, which invests in a basket of energy companies, has lost 13.6 percent over the last five years.
While BP stock has outperformed both XLE and XOM over the last five years, that isn't a reason to prefer BP over other energy stocks. It's important to look at other factors like valuation, growth outlook, and leverage.
Does XOM or BP offer better value?
BP stock trades at an NTM (next-12-month) EV-to-EBITDA multiple of 5.9x and an NTM PE multiple of 24.8x. In comparison, XOM stock trades at an NTM EV-to-EBITDA of 8.6x and an NTM PE multiple of 30.2x. Looking solely at the valuation multiples, BP stock seems to offer better value.
XOM has lower financial leverage than BP
The energy industry is capital intensive and companies have to borrow money to invest in new projects. However, high financial leverage increases the risk profile especially considering the volatility in energy prices. XOM had a net debt of almost $60 billion at the end of the third quarter of 2020. It's expected to post an adjusted EBITDA of $19.7 billion in 2020 and $32.8 billion in 2021. This would mean a 2021 net debt-to-EBITDA multiple of 1.8x.
Looking at BP, it had a net debt of $51 billion at the end of the third quarter of 2019. Its net debt-to-EBITDA multiple was 3.6x based on the 2020 estimated EBITDA and 1.83x based on the 2021 estimated EBITDA. Both BP and XOM have comparable leverage metrics based on the net debt-to-EBITDA multiple, which can be seen in the graph above. However, BP stock has high financial leverage based on the debt-to-equity ratio.
Why BP and XOM appeal to different investors
XOM has a dividend yield of 7.7 percent, while BP has a dividend yield of 5.7 percent. If you are an investor who craves dividends, you might prefer XOM stock. However, if you are more concerned about long growth capital appreciation, you should consider BP stock.
Both of these companies are set to release earnings this week along with other energy companies like Marathon Petroleum and ConocoPhillips. BP missed its earnings estimates in the quarter even though it posted a small profit. Wall Street analysts might also revise their ratings on these companies after the earnings release.