Top 2 High Yielding Energy Stocks for H2 2022

One of the hot topics of 2022 has been rising energy prices. The short version of the story is that years of underinvestment coupled with a crippling slowdown in 2020 reduced global oil and gas supply ahead of the 2021 economic growth rebound. The War in Ukraine and the Europe’s move away from dependence on Russian oil and gas has further stretched supply and inflated energy prices. However, over the past six weeks, West Texas Intermediate (WTI) crude oil prices have fallen from above $120 a barrel to below $95 a barrel. During the same period, the energy sector is down more than 23% against an 8% drop in the S&P500.

Chevron (CLC -0.83%) and Conoco Phillips (COP -0.90%) are two oil and gas stocks that have all sold off in recent weeks, but both look like good buys now. Here’s why.

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The Best All-Round Oil & Gas Major

Chevron CEO Michael Wirth has been in the spotlight recently as he publicly defended oil and gas producers against accusations that they are deliberately limiting supply to keep profit margins high. Chevron’s argument is that even if oil and gas companies wanted to increase production, it takes time to make new investments and bring supply into production. Additionally, companies like Chevron have mid- to long-term carbon reduction goals. Increasing production to help relieve pain at the pump can help the American consumer. But it’s a step in the wrong direction for climate change and goes against the strategic plans that Chevron has laid out.

That being said, Chevron has arguably been one of the slowest oil and gas companies when it comes to investing in low-carbon alternatives. This is partly because Chevron has an excellent low-cost oil and gas portfolio that can outperform the competition even when oil and gas prices are low. This position was posted in 2020 when Chevron lost less money than other oil majors, despite being second by market capitalization behind ExxonMobil.

CLC Net Income Graph (Annual)

CVX Data on Net Income (Annual) by YCharts

Chevron’s European peers have made far more significant investments in solar and wind energy. In contrast, Chevron is reducing its carbon footprint by investing in hydrogen and alternative fuels like diesel and natural gas produced from renewable feedstocks instead of fossil fuels. In this vein, Chevron remains within its circle of expertise, which makes sense given that Chevron is a relatively risk-averse oil major willing to insure bets and take little risk on speculative games. With a dividend yield of 4.1%, Chevron is an excellent large integrated company to consider now.

ConocoPhillips shareholders benefit directly from outsized profits

Like Chevron, ConocoPhillips operates one of the cheapest wallets in its peer group. But unlike Chevron, ConocoPhillips is a pure-play exploration and production company, meaning it has more upside from sustained high oil and gas prices, but also more risk.

However, ConocoPhillips offsets much of this risk by having a portfolio that can be free cash flow positive even when WTI oil is at $40 a barrel. Again, 2020 provides the perfect stress test for this claim. In 2020, WTI crude oil prices averaged $39.17 per barrel, according to the US Energy Information Administration. In 2020, ConocoPhillips had positive free cash flow. Chevron was too.

Table of free cash flow COP (annual)

COP Free Cash Flow data (annual) by YCharts.

Investors can look at ConocoPhillips’ ordinary dividend of $0.46 per quarter per share and argue that a 2.2% annual dividend isn’t exactly “high yield.” And they would be right. However, ConocoPhillips recently introduced a Variable Return Cash (VROC) program that pays shareholders additional special dividends based on the strength of the company’s earnings. These dividends have been substantial. In the first quarter, ConocoPhillips paid a VROC of $0.30 per share. And in the second quarter, it paid a VROC of $0.70. Add it all up and the company distributed $1.92 in dividends in the first half of 2022 alone. If he maintains that pace, his annual dividend yield is closer to 4% or 5%. VROC offers investors a direct way to profit from rising oil and gas prices. And ConocoPhillips’ low cost of production means that if times get tough, the company is well placed to support its ordinary dividend with free cash flow.

Effective asset portfolios for boom and bust cycles

Chevron and ConocoPhillips have similar strategies that are based on limiting the damage of a particular downturn while leaving room for the upside during boom times. This conservative approach means that neither company will benefit as much from high oil and gas prices as companies with high leverage that take riskier bets. However, when the market turns, Chevron and ConocoPhillips tend to be better positioned not only to limit losses, but also to make strategic acquisitions at bargain prices.

Chevron bought Noble Energy in 2020 for what looks like a steep discount in hindsight. Similarly, ConocoPhillips completed its acquisition of Concho Resources in early 2021, which reduced its cost of production and expanded its Permian Basin acreage. Add it all up and you have two high yielding dividend stocks that are poised to have a strong second half of 2022 and beyond.

Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.

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