Energy stocks have been a drag. They’ve been a drag for the past three years.

When sectors are vetted in the quarterly S&P 500 earnings releases, energy has repeatedly brought up the rear. Energy has occupied the bottom three — if not the bottom — sectors in earnings growth (frequently losses) since 2014.

But times, they are a-changin’.

FactSet data show that energy companies have reported the highest earnings growth of all sectors for the second quarter. The companies that constitute the S&P 500’s energy component reported earnings of $8.2 billion in the second quarter compared with $1.9 billion a year ago.

Energy Stock Pick #1: Best Dividend in Energy

The really big guys have weathered volatile (and falling) energy prices better than most. Now, they’re beginning to strut their stuff.

This includes BP PLC (NYSE: BP), one of the largest publicly traded integrated energy companies.

Though it was touch and go for a while, BP has maintained its high-yield dividend. The worst now appears to be over.

BP has adapted to the new environment as well as anyone. It has continually lowered its expenses to keep them in-line with oil prices.

Even more impressive, BP has been able to operate profitably with oil at the current level of $47/barrel. That’s allowed BP to generate $6.9 billion in free-cash flow in the first half of 2017.

BP’s goal is to drive down costs so the company can operate profitably even if crude oil trades in the $30s. With a lower cost structure, expanding margins are all but assured.

BP’s dividend yields 6.1%, the highest among the integrated giants. Best of all, BP’s high-yield dividend is as safe as it has been since the Deepwater Horizon tragedy seven years ago.

Energy Stock Pick #2: Best Value in Energy

On the other end of the spectrum, there’s an opportunity with the niche players. Nearly all have fared miserably compared to the integrated giants. Few energy niches have fared more miserably than the offshore drillers.

The offshore drilling business is oh-so very cyclical.

The offshore drillers — the companies that supply the integrated giants with the monster offshore drillships and rigs — were notable beneficiaries of the 2006 – 2008 oil boom. Most offshore drillers had their shares bid to all-time highs in 2008. Earnings were flowing in as prodigiously as oil flowed out of newly drilled wells.

But it didn’t last. It never does.

The offshore drillers — once floating atop luxuriant valuations — have sat drydocked for the past three years. The all-time high values of a decade ago have given way to all-time low values today.

Rare is the analyst with the name of an offshore driller atop his recommendation list. Bully for us, because the offshore drillers are rising to the top of my recommendation list.

None has risen further than Diamond Offshore Drilling (NYSE: DO), a leading offshore driller.

Diamond has endured the down-cycles before. And it has not only endured, but prospered. Diamond is majority owned by Loews Corp. (NYSE: L), which is run by the Tisch family. The Tisches are skilled value managers capable of exploiting opportunities.

For example, Diamond acquired 39 offshore drilling rigs from Murphy Oil (NYSE: MUR) for $372 million in the early 1990s. Diamond paid a price that is less than half of what a single new build deepwater semi-submersible would cost today.

Diamond even makes money in the dreary drilling market. The company has earned $1.11 per share over the past three quarters. Diamond will earn money this year. I expect EPS of $0.91 in 2017.

Diamond shares had traded at a mere one-third of book value as recently as August. The shares have rallied 55% over the past two months. Yet despite the recent gains, the shares still trade at half of book value. They still trade at an 80% discount to the five-year high of $75.

Energy investments have rarely been so cheap over the past 30 years. This energy stock pick has never been this cheap. That’s a fact worth pondering. The last time Diamond was close to being this cheap, in 1995, investors were able to turn every $1,000 investment into $10,000 within a decade.

— Steve Mauzy

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Source: Wyatt Investment Research