This year’s stock market rally has most indexes trading at much higher valuations. The S&P 500 currently trades at more than 20 times earnings, while the Nasdaq 100 fetches more than 25 times earnings. While that’s not in nosebleed territory, it’s not cheap either.
The rise in stock prices certainly leaves value-conscious investors with fewer options. However, they do have some, especially in the energy sector. Three top bargains are Energy Transfer (ET), Diamondback Energy (FANG), and Brookfield Infrastructure (BIP) (BIPC). Here’s why bargain-hunting investors shouldn’t hesitate to buy shares right now.
Low value drives the high yield
Energy Transfer currently trades at a bottom-of-the-barrel valuation. If the master limited partnership (MLP) sold at the same valuation multiple of its peers, it would fetch about $24 per unit. That’s over 75% above its current unit price. Meanwhile, the analysts’ consensus price target is $17 per unit, implying nearly 25% upside potential.
The company expects to produce about $7.5 billion in distributable cash flow annually. Its distribution currently costs around $4 billion, enabling it to retain about $3.5 billion in cash each year. That will give it plenty of money to fund its expansion program of about $2 billion to $3 billion per year. The company plans to use its excess cash flow to continue strengthening its already solid balance sheet and repurchase its dirt cheap units.
Energy Transfer anticipates that growth-related capital projects and acquisitions will give it the fuel to grow its already attractive distribution by 3% to 5% per year. That combination of steadily rising income, earnings growth, and value-based upside potential makes the MLP look like an extremely compelling investment opportunity.
Getting cheaper the higher oil prices go
Diamondback Energy has become a cash flow machine. The oil company expects to produce around $2.8 billion in free cash flow this year, assuming oil averages slightly less than $80 per barrel. That works out to more than $15 per share. With shares recently trading around $150 apiece, Diamondback trades at about 10 times free cash flow.
In addition to the boost from higher oil prices, Diamondback is growing its production by drilling more wells. On top of that, it should start seeing some service cost deflation as contracts come up for renewal. These factors put the company on track to produce an even bigger free cash flow gusher next year.
Diamondback aims to return at least 75% of its free cash flow to shareholders through its base dividend, share repurchases, and a variable dividend. It has been using most of its capital return flexibility after paying the base dividend to repurchase shares. It bought back another $321 million of stock in the second quarter at an average price of $132.21 per share. Given how cheap shares remain, especially after the recent oil price increase, Diamondback will likely continue gobbling up its dirt cheap stock.
Healthy growth for a dirt cheap price
Brookfield Infrastructure expects to increase its funds from operations (FFO) by about 10% per unit this year, pushing it up to around $3.00. With partnership units (BIP) recently trading around $32 apiece, Brookfield fetches less than 11 times its earnings. Meanwhile, even the economically equivalent corporate shares (BIPC) are pretty cheap at around $37 apiece, or a little more than 12 times earnings.
Brookfield’s growing cash flow should give it the fuel to continue increasing its dividend. The company plans to expand its payout, which yields over 4% for both entities, by 5% to 9% per year. That combination of income and growth for a value price makes Brookfield Infrastructure look like a steal these days.
Bottom-of-the-barrel valuations
Energy Transfer, Diamondback Energy, and Brookfield Infrastructure are downright bargains. The companies trade at low valuations despite producing rising cash flows. That’s giving them more money to reinvest in growing their operations and to return to investors.
That combination of growth, income, and value could enable this trio to produce strong total returns in the future. Because of that, value-seeking investors shouldn’t hesitate to add them to their portfolios.
— Matthew DiLallo
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Source: The Motley Fool
