As we head into the summer driving season, crude oil prices have retreated from their April highs. As a result, the energy sector has been one of the worst-performing sectors over the past month. However, considering the sector’s bargain valuation, looking for the best energy stocks to buy will reward patient investors.
Energy stocks are one of the most undervalued sectors on an absolute basis. According to Goldman Sachs (NYSE:GS), energy stocks trade at a next 12-month (NTM) price-to-earnings of 11.8 and a 6.7% free cash flow yield. That’s a significant discount to the S&P 500’s 20.9 times NTM P/E. Maybe more to the point, the market has yet to appreciate the cost discipline and shareholder return focus that most energy stocks have adopted.
The following bargain companies have premier assets that will support production growth going forward. Furthermore, they are generating significant cash and returning it to shareholders through buybacks and dividends. These three stocks are the best energy stocks to buy for gains and returns.
Texas Pacific Land (TPL)
Unlike other energy companies that explore and produce oil and gas, Texas Pacific Land (NYSE:TPL) operates in a unique model. It leases its land to oil companies and earns royalties on the production of its land. This unique model allows it to transfer operating risks and helps it maintain best-in-class profit margins.
Considering its unique model, TPL stock should be on your list of the best energy stocks to buy. Texas Pacific Land owns 868,000 surface acres in Texas. Besides oil and gas royalties, it also draws revenues from water rights and leasing activities.
Since Texas Pacific has minimal operating expenses and no capital burden, it generates high margins from its revenue streams. For instance, in 2023, revenues were $632 million and generated $541 million in adjusted EBITDA, translating into an impressive 86% margin. Free cash flow margins were also a high of 66%.
Due to its efficient conversion of revenue to cash, this energy stock will continue to deliver impressive shareholder returns. Lastly, Texas Pacific will join the S&P MidCap 400 on June 24, creating demand from passive buyers.
Chevron (CVX)
Oil supermajor Chevron (NYSE:CVX) is in a top-tier group of the best energy stocks to buy. Besides its bargain at 12 times forward P/E, there has been progress regarding the Hess (NYSE:HES) acquisition. On May 28, a majority of Hess shareholders approved the $53 billion merger. Still, a Federal Trade Commission probe and an arbitration dispute are ahead.
Isolating the Hess problems, Chevron continues to execute flawlessly. In Q1 2024, it exhibited strong returns across the board, delivering 12% year-over-year worldwide production growth. However, earnings declined due to lower natural gas realizations and lower refined product margins.
In terms of return on capital employed, the oil giant continued its stellar record, achieving a return of more than 12%. On that note, it returned $6 billion to shareholders — $3 billion in dividends and $3 billion in share repurchases. This was the eighth straight quarter of over $5 billion in shareholder returns.
Management also highlighted the huge growth opportunity from its Tengizchevroil affiliate in Kazakhstan. There has been significant progress in the Future Growth Project, with operations expected to commence in the first half of 2025. The company expects over one million barrels of oil equivalent per day once production starts. With FGP expected to generate $5 billion in annual free cash flow at $60 Brent crude, this oil major will continue its shareholder returns.
Devon Energy (DVN)
Devon Energy (NYSE:DVN) is at the nexus of the deal-making environment that has swept the Permian basin. There has been $194 billion worth of deals since July 2023, the major ones being ExxonMobil’s (NYSE:XOM) $64.5 billion acquisition of Pioneer Natural Resources and the $26 billion acquisition of Endeavor Energy Resources by Diamondback Energy (NASDAQ:FANG).
Analysts have argued that Devon missed out due to its production issues and higher drilling costs, which made its stock unattractive to takeover targets. However, some opine that it lost out to competitors due to its price discipline. If so, that’s a positive since it reflects management’s commitment to preserving shareholder value.
As of this writing, Devon and EOG Resources (NYSE:EOG) are the largest U.S. oil and gas producers that haven’t struck a deal. Still, there are plenty of smaller targets that Devon could pursue that would be accretive. Moreover, it could also become a target itself from larger players. Either way, Devon is one of the best energy stocks to buy at these levels.
At a forward P/E of 9 and a trailing EV/EBITDA multiple of 5, DVN stock presents a significant opportunity for bargain hunters. An acquisition could add considerable value, or Devon could be acquired at a substantial premium.
On the date of publication, Charles Munyi did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
