13 Stocks That Benefit From Lower Oil Prices

There’s no question that lower oil prices are good for drivers: What’s not to like about gasoline at less than $3 a gallon? But the drop in crude prices is a mixed bag for the economy and the stock market—and therefore, for investors. To borrow a metaphor from Bank of America Merrill Lynch, lower oil prices can act as a lubricant for your portfolio—or they can be an oil slick. Here’s what you need to know to take advantage of plunging energy prices, while avoiding the pitfalls.

The price of West Texas Intermediate crude oil has plunged more than 30%, to roughly $75 per barrel, since mid June. Behind the fall is a classic tale of supply and demand. Production, particularly in the shale boomtowns of the U.S., has surged. The U.S. became the world’s largest oil producer earlier this year, unseating Saudi Arabia.

At the same time, demand has fallen, thanks to weakening overseas economies. Japan’s economy is in recession, for instance, and much of Europe is teetering near recession. The International Energy Agency had estimated demand growth of 1.3 million barrels per day for 2014. It recently revised its forecast to growth of just 700,000 barrels per day, below average demand growth for both 2012 and 2013.A strengthening dollar is doing its part to keep oil prices down, too. Because global oil markets are priced in greenbacks, the price of oil typically moves in the opposite direction of the dollar.

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The key for investors is not how far oil has fallen already but whether it will stay low or fall even further. A dip below $75 per barrel in coming weeks can’t be ruled out, but Kiplinger sees WTI crude trending upward, to $85 to $90 a barrel by February. The longer prices stay low, the more pronounced the impact—for good or bad.Sustained lower prices are a net plus for the economy. “In our consumption-oriented economy, with 68% of gross domestic product driven by consumer spending, lower oil and other energy prices act as a tax cut for consumers,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. For every $10 taken off the price of a barrel of oil on an annualized basis, add as much as one-quarter percentage point to growth in gross domestic product, figures BofA.

Corporate profits, however, are more geared toward business spending and commodity prices, so falling oil would not be good news for the majority of companies in Standard & Poor’s 500-stock index. Not surprisingly, energy companies see the biggest earnings hits when oil prices sink, followed by industrial companies and concerns that produce and process raw materials. If oil prices were to hold at current levels, it would shave $2 to $3 from estimated 2015 profits of $127 per share for the S&P 500, says BofA.

Nonetheless, stock market bulls need not surrender to oil’s woes. Brian Belski, chief investment strategist at BMO Capital Markets, says stocks have done just fine without the participation of the energy sector throughout much of the bull market, which celebrates its sixth birthday in March. His research shows that since 1970, the S&P 500 has gained an average of 19% in calendar years during which energy stocks lagged the market, but only 2% when energy beat the market.

Where can investors cash in on the slide in oil prices? Look for companies that will save on their own energy costs. Or find companies that cater to consumers who might be inclined to spend the money they’re saving on gas. Firms with the best prospects serve customers with below-average incomes, for whom savings at the pump have the most impact on the family budget.

Lower fuel prices provide an obvious jolt to transportation companies. And even though airlines have been the best-performing industry over the past two years, it’s not too late to buy, say strategists at Morgan Stanley. They give Delta Airlines (DAL, $45) and Jet Blue (JBLU, $13) their top rankings. Delivery giant United Parcel Service (UPS, $106) already enjoys a cost and efficiency advantage within its industry. UPS has a history of using the bountiful amounts of cash its business generates to buy back stock and raise its dividend, says S&P Capital IQ, which recommends the stock. (All share prices are as of November 18.)

Companies that make paints, stains and other coatings save on raw materials when energy costs fall. But the prices that consumers pay for their finished products tend to hold firm, resulting in improved profit margins, says portfolio manager Saira Malik, at TIAA-CREF. She recommends PPG Industries (PPG, $209), which makes house paint under the Glidden and Pittsburgh Paint brands. PPG also makes protective coatings for everything from cars to jets, as well as other industrial materials. Another stock to consider is Valspar (VAL, $85). The company recently launched a premium paint at Lowe’s and began to sell its Valspar brand at more than 3,000 Ace Hardware stores. The stock should be a profitable holding over the next three to five years, according to the Value Line Investment Survey, based on the company’s increasing share of a growing worldwide market and the stock’s dependable dividend.

A drop in oil prices delivers a twofold boost to Goodyear Tire & Rubber (GT, $26). Profit margins become plumper because of lower raw materials costs. Plus, more-affordable gasoline tends to increase the number of miles people drive, sending them to the tire store sooner. S&P Capital IQ recently boosted its call on the stock from “buy” to “strong buy.” Berry Plastics (BERY, $26) will also realize significant savings on raw-material costs. The company makes the drink cups you get at many fast-food restaurants, as well as other plastic packaging and containers, including prescription drug vials and caps and the plastic food wrapping used in grocery stores. Cliff Greenberg, manager of Baron Small Cap Fund (BSCFX), a member of the Kiplinger 25, is a believer; Berry is one of the fund’s biggest holdings.

Consumer-oriented stocks worth a look include warehouse club colossus Costco (COST, $139), which is already enjoying stronger profits on its gasoline sales. When gas prices are flat to down, “we save the customer more, and we make more,” chief financial officer Richard Galanti remarked during Costco’s most recent quarterly earnings call. Lower gas prices provide a meaningful lift for customers of Wal-Mart Stores (WMT, $84), recommended by Raymond James Securities. But its shares surged after the retailer reported better-than-expected earnings for the quarter that ended October 31, so you might want to buy in cautiously. Other retailers catering to bargain-hungry shoppers include Target (TGT, $68), Burlington Stores (BURL, $41) and Dollar General (DG, $66). All of them should produce greater returns than the market overall over the coming year, says BMO Capital Markets.

Finally, don’t overlook bargains in the oil patch itself—the companies aren’t, as indicated by the November 17 announcement that energy-services giant Halliburton (HAL, $49) will acquire its smaller rival Baker Hughes (BHI, $64) in a cash and stock deal worth nearly $35 billion.

Most wells remain profitable with oil prices at current levels, says BofA, with some still ahead all the way down to $40 a barrel. And integrated energy companies, which not only produce but also refine crude oil, are somewhat insulated against the effects of falling prices. Shares of integrated giant Chevron Corp. (CVX, $115) also yield an eye-popping 3.7%, well above the overall market’s 2.0% yield; Morningstar says the stock should trade for $132 per share.