Energy Stocks Worth Keeping

Oil's down, but analysts still like these names.

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Oil prices, which peaked above $147 a barrel in May and retreated by nearly a quarter before rebounding a bit to around $114 last week, have investors asking if this year's long run in energy stocks might be starting to reverse.

It's possible. Developed country demand is declining—including in the United States, where high prices finally led consumers to cut back at the pump. That, combined with lower demand from emerging markets, a return to favor among some other sectors on Wall Street, and the fact that oil stocks have had a great run make energy a less sure bet than it's been all year.

That doesn't mean there aren't bargains to be had. Now that much of the energy sector has taken a beating, analysts continue to tout their favorite names.

Valuations in the sector have indeed come down substantially.

A week ago, Barron's Andrew Bary predicted energy stocks could easily rise 25 percent or more over the next year because most of the major oil and gas companies are now trading below 10 times earnings.

Tim Parker, an energy analyst with the T. Rowe Price New Era fund, which invests heavily in energy-related plays, says oilfield service firms could still do well, too. Parker still likes oil service giant Schlumberger (SLB). The bellwether of the group is trading at around 16 times forward earnings where it historically trades closer to 30. As for smaller names, he likes BJ Services Co. (BJS), which makes pressure pumpers used to pull natural gas out of fields. The wealth of new shale drilling in the United States, plus an end to a glut in the market for the sort of equipment over the past few years could boost shares even if natural gas prices hold near where they are now, he said.

Parker's less excited about oil and natural gas producers in the near term in case the decline in energy prices continues. "I'm more hesitant to go all-in on producers given the commodity price backdrop," he says. He does, however, like the industry's largest companies.

He also thinks the oil majors—Exxon, Chevron, and the like—could be ready to grow more quickly in the next couple of years than they have during the past few when major efforts to beef up production, including Exxon's (XOM) liquefied natural gas projects in Qatar (plus its cheap valuation at 7.5 times forward earnings) and Chevron's (CVX) operations in Nigeria and in Kazakhstan's Tengiz field are taken into account.

"They look to me like they're on the cusp of growth," he says.

Plus, analysts say keeping a bit of energy in the portfolio is a good thing, since many firms continue to offer dividend yields, and a good number have been buying back stock on weakness in their share prices.

Natural gas-related stocks remain a weak spot, however. Shares of hot names like Devon Energy (DVN) and XTO Energy (XTO) have given back almost all of this year's gains.

Starting in March, the price of natural gas soared from around $9 BCF to nearly $14 BCF around mid-June, before slumping back to around $8 today in a chart pattern resembling a slightly lopsided dunce cap. At the same time, lots of new U.S. drilling makes excess production a threat to prices as well.

Bulls say oversupply concerns are valid, though worst-case scenarios tend to overlook the difficulty of extracting gas from many of the new U.S. fields. Plus, building enough pipelines and rigs to extract the stuff is proving difficult. "The market's getting too negative on U.S. natural gas, too," says John Senger, senior portfolio manager with the AIM Energy Fund.

Senger is picking names that look cheap now: Occidental Petroleum (OXY), Apache (APA), two names growing production in the double digits, and National Oilwell Varco (NOV), another oil services name with a respectable backlog of work. "I consider this in general one of the best buying opportunities I've seen for a long time in energy," he says.

The steep climb seen earlier this year is unlikely to be repeated, however, as other factors could hold shares back.

The first is financials. Bank stocks have bounced back from lows following the Fannie Mae/Freddie Mac turmoil. The KBW Bank Index is up more than 30 percent in the last month. That's causing some investors to consider taking some of those energy profits to reinvest in beaten-down financial names. Sector rotation among investors who used energy stocks as a safe haven could be "the major headwind," Senger says.