Big integrated energy companies, such as Royal Dutch Shell  (ticker: RDSA), ExxonMobil  (XOM), and Chevron  (CVX), have held up far better, supported by their lush dividend yields, which now range between 3% and 6%. But even among this group, not all are created equal.
We surveyed the oil patch to find the most attractive investment opportunities among large producers and integrated oils, paying special attention to pristine balance sheets and operating costs. They include Royal Dutch and Chevron, among the super majors; Occidental Petroleum (OXY), and EOG Resources  (EOG). Schlumberger  (SLB), the gold standard among oil-services companies, also made the cut, offering investors a rare chance to buy the high-quality stock on the cheap.
WHILE OIL PRICES could eventually rise from a current mid-$50s levels, they will remain volatile. What’s more, the stocks don’t appear to be trading on fundamentals alone. The group rebounded last week despite the continued slide in the price of crude, a result, some analysts said, of likely short-covering in anticipation of a rally. Oppenheimer analyst Fadel Gheit warned against bottom-fishing amid the volatility, stating in an e-mail, “At the current oil prices, ALL oil stocks are overvalued by historical metrics, as they are currently reflecting $70 to $80 oil.”

The supply-demand imbalance causing the drop in the price of crude doesn’t look like it will sort itself out in the short run. Oil demand is poised to fall below its historic growth rate this year and next, while supply shows no signs of declining. Saudi Arabia has maintained production amid the drop in prices, and even offered discounts to some customers; the country is keen to show the world it still controls the price and availability of oil.
There are few signs that U.S. production, which has grown 90% in the past six years, will slow in the near term; analysts don’t expect it to fall until 2016 at the earliest. The interim period is likely to see some of the riskier companies either go out of business or be purchased in fire-sale deals.
With the smaller explorers and producers “you’re gambling on their survivability,” says Christian Ledoux, senior portfolio manager and director of equity research at South Texas Money Management. “A lot of them won’t be able to explore profitably.”
There is reason for optimism. Some observers, even ones who helped guide Barron’s cover story predicting the oil plunge (“Here Comes $75 Oil,” March 31), don’t expect oil to stay below $60 for long, even if it temporarily slips below $40. Citigroup’s head of global commodity research, Edward Morse, believes $90 will become the new ceiling for oil, whereas it had been the floor for several years.
Others agree that the price will eventually rebound, with oil probably trading around $70 or $75 on average over the next two years. Most shale projects, which account for about half of U.S. production, remain profitable when oil prices are $70, although there is wide variation by project.
“This is a temporary condition,” says Lori Heinel, the chief portfolio strategist at State Street Global Advisors. “We don’t think the long-term price of oil is south of $60.”
THE FIRST PLACE to look when oil prices fall is often the super majors, large integrated oil companies that tend to fall less dramatically than smaller producers. Each of these companies -- ExxonMobil, Royal Dutch, BP  (BP), ConocoPhillips  (COP), Chevron, and Total (TOT) -- has made dividends a priority, and is unlikely to cut them during the turmoil ahead. But two, Royal Dutch and Chevron, offer better value than others.
Investors have seldom gone wrong buying ExxonMobil on the dip, but the shares, down just 10% since June, haven’t fallen as far as competitors. Its purchase in 2010 of gas explorer XTO made its production more heavily weighted to natural gas, which could remain depressed longer than oil. We also took a pass on ConocoPhillips, which spun off its refining and chemicals operations in 2012, making it slightly more vulnerable to the pullback. And while BP looks inexpensive -- and sports a 6% dividend yield -- it carries more debt than competitors. A legal decision related to its 2010 Gulf spill could result in fines as high as $18 billion. Total also carries a higher percentage of debt than its rivals.
As a general rule, patience makes sense in volatile times. And we were admittedly early two months ago when we recommended wading back into oil stocks (“12 Ways to Play the Energy Slump,” Oct. 27).
Large oil stocks, which have rallied 10% from Monday’s low, could fall again before they turn around. But at current prices, they still offer a cheap entry point for investors.

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Royal Dutch and Chevron have fortress-like balance sheets, high yields, and resilience to swings in the price of oil. Occidental has a 3.8% yield and is buying back 10% of its stock. EOG is self-funding and its break-even price is less than $60 a barrel, among the lowest in the industry. And Schlumberger, the gold standard in the oil-services industry, could gain market share when oil prices revive.

Company / Ticker Recent Price Market Value (bil) % Change Since 6/20 Revenue 2014E(bil) Net Income 2014E(bil) EPS 2014E EPS 2015E P/E 2015E Dividend Yield Net Debt / Capital
Chevron / CVX$112.93$213-14.7%$214$19.1$9.82$7.8814.33.8%6.1%
EOG Resources / EOG95.0252-19.5183.15.323.3528.40.718.7
Occidental Petroleum / OXY81.5263-18.3244.86.124.0720.03.510.6
Royal Dutch Shell / RDSA  68.69  219-16.6  434  21.5  7.31  6.28 10.95.510.7
Schlumberger / SLB87.52113-19.6497.35.565.3516.41.811.8
E=Estimate Sources: FactSet; Bloomberg

ROYAL DUTCH BOASTS a 5.5% dividend yield, and few investors believe the payout is in jeopardy, given the $19 billion in cash on its balance sheet. That alone should whet investors’ appetites. Royal Dutch stock has fallen 17% since oil peaked. The company has acknowledged that its earnings are sensitive to oil prices, saying in October that every $10 drop in oil prices this year will sap $3.2 billion in annual profits.
That’s significant but not crippling to a company that’s expected to earn $21.5 billion, or $7.31 a share, in 2014. Royal Dutch has a market value of $219 billion, second only to ExxonMobil’s $397 billion.
CEO Ben van Beurden, who took over in January, is intent on cutting costs and growing free cash flow, even at the expense of production growth. The company sold more than $11 billion in assets this year, including much of its U.S. shale portfolio, and is on track to reduce its oil and gas production by about 11% this year, according to Gheit. That puts it in a stronger position as the downturn sets in.
“It headed into this downturn as one of the few oil majors with noticeable momentum from restructuring, which should help it during this period,” says Jason Clark, a senior portfolio manager at AFAM Capital.
“All of the European big energy companies have easy-to-articulate problems. Investors tend to do better when they are buying things with problems that are well-known. Plus, yields are double that of their U.S. peers,” says Bryce Fegley, analyst at Saturna Capital.
Worth noting, the Royal Dutch A shares are taxed in the Netherlands, while the B shares are not.
CHEVRON ALSO STANDS out among the U.S. oil stocks because of its high dividend yield -- 3.8% at current prices. And investors are confident the payout isn’t going anywhere. “It’s at a multidecade high, and this is a company that doesn’t cut its dividend,” says Ledoux, the Texas money manager.

High Debt

The five oil and gas producers below have some of the highest net debt-to-capital ratios in the industry, which prove problematic if oil prices stay low.

Company Ticker Recent Price Market Val (bil) Net Debt /Capital
Ultra PetroleumUPL  $15.38  $2.4 115.0%
EXCO ResourcesXCO  2.48 0.7 90.3
Halcon ResourcesHK2.07 0.9 68.7
W&T OffshoreWTI7.14 0.6 68.1
Energy XXIEXXI3.16 0.3 65.2
Source: Bloomberg

The company has spent heavily on capital projects, including a $54 billion liquefied natural gas project in Australia, and is expected to post negative $4.7 billion in free cash flow next year. But that project was 87% complete as of October and should start operating in mid-2015.
Free cash flow could turn positive again in 2016. In the meantime, Chevron has a comfortable cushion, as net debt makes up just 6% of its total capital. And it could pay off most of that debt today with its $14.5 billion in cash. Chevron is the least expensive of the U.S. super majors on a price/earnings basis, trading at 14.3 times expected 2015 earnings. Its downstream assets, including marketing and refining operations, can also buffer losses in oil production.
WHILE MANY SMALLER oil and gas producers appear risky, Occidental, with a $63 billion market value, came into the downturn well-positioned. The company is clearly exposed to falling oil prices, but it’s got one of the cleanest balance sheets in the industry, generating more than enough free cash flow last year alone to pay off its entire net debt. The stock yields 3.5%, and Sterne Agee analyst Tim Rezvan expects the company to continue to raise the dividend even during the oil slump. Management also plans to buy back about 9.8% of its shares, which are trading near a two-year low.
“A $6 billion repurchase should not be overlooked, and is likely to help set a floor value for shares at/near the current level, with crude at about $57 a barrel,” Rezvan wrote last week in upgrading the shares to Buy. He sees shares rising to $94 from a recent $81.52.
EOG, ONE OF the most successful shale drillers, also looks like a value at these prices, after seeing its shares fall 20% since June. EOG has chosen its drilling spots carefully, and its average break-even price is among the lowest in the industry -- less than $60 a barrel, according to Morningstar analyst Mark Hanson.
Its balance sheet, with net debt at just 19% of total capital, beats peers like Continental Resources      (CLR), which carries net debt of 53%.
EOG has “probably the best management team in Houston,” says Jeff Bellman, an analyst at TIAA-CREF Asset Management who says the company is one of his favorites. “EOG has one of the few business models that can grow within its cash flow, while some shale producers are hurting because they overspent and now have leveraged balance sheets.”
Although EOG’s dividend yield, at 0.7%, is skimpy for an oil producer, the company raised it twice in 2014, while remaining financially conservative. It plans to fund its dividend and capital expenditures internally, instead of raising debt. For now, it makes sense for EOG to invest its earnings right back into production, because the company’s shale plays are particularly lucrative, even at low oil prices.
“EOG has significant reinvestment opportunities in the Eagle Ford, Bakken, and Delaware Basin that can generate after-tax rates of return of 100% or greater at $80 [a barrel]” writes Gheit. “At $40 oil it can still achieve a 10% direct after-tax rate of return in the Eagle Ford, the Bakken Three Forks, and the Delaware plays.”
INVESTORS ARE WARY of oil service stocks, and with good reason. Oil producers are looking for ways to cut capital expenses, and could take an ax to their shale-drilling and offshore budgets in the coming months. “As a group they could see 15% to 20% capex cuts,” says Tim Parker, an energy specialist at T. Rowe Price.
After a 20% decline since June, Schlumberger is trading at 15.9 times forward earnings expectations, below its average multiple of 16.9. Although it has increased its bets on North American shale drilling, and could be vulnerable, Schlumberger has chosen its exposure carefully and should have protection in the downturn.
In our cover story this summer, we said shares of the $49 billion in revenue company, then $106, could rise 50% or more (“Right on Target,” Aug. 18). Now $87.52, the stock looks like an even bigger bargain.
Investors are comfortable with the company’s balance sheet, and its commitment to return capital.
Schlumberger bought back 1% of its shares in the last quarter alone and has raised its dividend three years in a row; shares now yield 1.8%, more than Halliburton  (HAL) and Baker Hughes (BHI). When the merger of those two competitors closes, Schlumberger should be well-positioned, some analysts say.
“Once markets recover, the company could see better margins and pricing power internationally, as well as improving market share,” says Dimitry Dayen, an analyst at asset manager ClearBridge Investments.
There’s still plenty of risk in oil stocks, and investors who get in now could see the group fall before it turns around. But by focusing on the best in the business, you can establish a position that will likely pay off for years to come.