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Energy stocks were one of the hottest sectors in the market in 2022. Between the onset of the war in Ukraine, surging inflation and concerns around macroeconomic policy, oil and gas were in the right place at the right time.
However, things have moved in a sharply different direction more recently. The price of oil has slipped below the $75 per barrel mark again after moving above $100 last year. Meanwhile, the price of natural gas has experienced a full-on collapse following unfavorable winter weather.
But the long-term outlook for energy still appears to be favorable.
Over the past decade, few energy companies were willing to invest heavily in the sector amid the prolonged period of lower energy prices. In addition, regulatory constraints and environmental concerns have made it increasingly difficult for energy companies to tap into new supply. This should bode well for companies with an existing strong position in the industry, such as these three undervalued energy stocks.
Valero Energy (VLO)
Valero Energy (NYSE:VLO) is the world’s largest independent refining company with 15 different refining locations. Its scale and efficient operations have made it the lowest-cost refining outfit as well.
Historically, refining has been a challenging industry. For decades, American refineries earned low profit margins and were subject to a brutal boom-bust cycle. But things have changed. For one, no meaningful new refineries have been built in America in decades, meanwhile some have closed down, which has improved the supply and demand picture. For another, the rise of fracking and other new oil production in North America has produced cheaper crude and led to higher refining margins versus imported feedstocks.
Valero has generated windfall profits in recent years and is putting them to good use. It now has a dozen ethanol plants and produces 1.2 billion gallons per year of renewable diesel, giving it a leg up on the next era of fuel production.
Despite the core improvements in the business, investors aren’t giving the company much credit. VLO stock has slumped nearly 20% over the past month, leaving shares at just 5 times forward earnings. That’s a bargain.
Halliburton Energy (HAL)
With the revival in the energy sector since 2021, some demand has finally returned for new oil and gas drilling. Thanks to this, the long-dormant energy services sector has come roaring back to life.
Halliburton Energy (NYSE:HAL) is a global leader in oilfield services, with extensive operations in North America, Latin America and the Middle East. Specifically, it helps oil producers with needs such as cementing, completion fluids, wireline solutions and much more. It has a particularly strong position in offshore oil fields, which can often be more lucrative.
Given the underinvestment in the sector in recent years, there is currently a favorable supply and demand balance for companies such as Halliburton. This leads to strong pricing and profit margins.
HAL stock has fallen 24% year-to-date. This puts shares at just 9 times forward earnings. Morningstar (NASDAQ:MORN) analyst Katherine Olexa views this as a compelling offer, with a fair value target of $40.
Enbridge (NYSE:ENB) is one of the dominant energy midstream companies in North America. It has a massive web of natural gas and liquids pipelines running between Boston, Orlando, Houston, Vancouver and countless points in-between. In addition, it has invested in power generation, producing enough power to be capable of serving approximately 966,000 homes.
Enbridge is also focused heavily on shareholder returns. It has produced $1.2 billion in cost savings since 2017 while selling off various assets and making attractive investments in others at single-digit multiples. Enbridge has been a textbook example of how to modernize a business and move it toward improving sustainability and environmental targets while also producing shareholder value.
The big appeal to ENB stock today is its compelling 6.8% dividend yield. There are plenty of high dividend yields out there in the market. However, it’s rare to get such a fat yield from a massive mission-critical business such as Enbridge with strong inflation-protected cash flows. The company also has a safe BBB+ credit rating, which stands out in an energy landscape where many companies have much less sturdy balance sheets.
On the date of publication, Ian Bezek held a long position in ENB stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.