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Industry Outlook

Crude oil – considered to be in a bear market – is currently down significantly from its recent highs.

Is now the time to be buying energy stocks?

While record high inventories and robust production could still push the commodity to the depths of multiyear lows, signs are emerging that oil prices are likely to stabilize and gradually pick up. Not only is global demand expanding but energy companies have significantly scaled back on plans to explore for and bring out more oil. This should lead to lower future production and supply/demand rebalancing.

However, not all oil stocks are the same. In fact, one needs to have an appetite for risk in order to invest in the energy sector. For savvy investors though, there are opportunities to earn big returns.

Look at E&Ps with Strong Balance Sheets

While all oil/gas-related stocks stand to move with fluctuating commodity prices, companies in the exploration and production (E&P) sector tend to be the most affected, as their product’s values are directly dependent on oil/gas prices.

However, some upstream energy companies stand out from others with their ability to absorb volatile prices. These entities have restructured costs or taken other measures to deal with the prevailing situation. In this event, it may be a good idea to look at energy companies that have low debt capital ratios, which make debt servicing relatively easier for them.

They boast of a conservative balance sheet with enough cash on hand and a manageable leverage. This provides the companies ample flexibility to make acquisitions or grow internally. Moreover, driven by operational efficiencies, these entities have been able to reduce unit costs -- an impressive achievement amid the low realization scenario.

We advocate the likes of Devon Energy Corp. (DVN - Free Report) , EOG Resources Inc. (EOG - Free Report) and Cimarex Energy Co. (XEC - Free Report) -- all large-cap companies.

Integrated Majors Still Attractive

In this current turbulent market environment, we advocate the relatively low-risk energy conglomerate business structures of the large-cap integrateds, with their fortress-like balance sheets, ample free cash flows even in a low oil price environment and steady dividends.

Thanks to their integrated structures, companies like TOTAL S.A. (TOT - Free Report) , Chevron Corp. (CVX - Free Report) , and Eni SpA (E - Free Report) have been able to withstand plunging oil prices better than the rest and protect their top and bottom lines to a certain extent.

The companies’ financial flexibility and strong balance sheet provide them with a larger war chest to draw upon in this highly-uncertain period for the economy. Most of them remain in excellent financial health, with ample cash on hand and investment-grade credit ratings with a manageable debt-to-capitalization ratio. On top of this, managements have established quite a track record of conservative capital management and cash returns to shareholders. They also pay a safe dividend, yielding attractive returns.

While all of them have suffered from the crude carnage over the past 24 months, holding on to them can still prove to be an astute move.

MLPs: A Safer Way to Play the Sector

The Master Limited Partnership (MLP) business model looked like a goner earlier this year. As oil prices plummeted to a 13-year low in Feb, the Alerian MLP index dived 30% in just five weeks. However, market sentiment has improved considerably thereafter.

Importantly, the collapse in crude has markedly reduced the average price of U.S. gasoline, the most widely used petroleum product. This has resulted in record gasoline volumes across pipeline systems and a boon for operators whose compensation is based on the quantity moving through their system.

Given the current weaknesses in petroleum stocks, MLPs are probably the best method of investing in the sector. They also offer liquidity and tax benefits, which add to their appeal. This is why these stocks would make good additions to your portfolio.

With capital market access remaining tough for most sector components, we suggest buying stocks with clean balance sheets. Our picks would include the likes of Enbridge Energy Partners L.P. (EEP - Free Report) , Archrock Partners L.P. (APLP - Free Report) and CONE Midstream Partners L.P. (CNNX - Free Report) .

Check out our latest Oil & Gas Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy.

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