. The combination of low investment in new oil wells as rising demand highlights what could be a prolonged period of high energy commodity prices. Meanwhile, many oil and gas stocks are still trading at low valuations to expected earnings despite a sector-wide rally stretching back to the end of 2020.
Even though the energy sector of the S&P 500
The only one that has risen this year is the stock market. Investors seem to still be in an early stage of a multi-year cycle that will prove lucrative.
Simon Wong in New York is an analyst at Gabelli Funds. Charles Lemonides in New York is the chief investment officer at ValueWorks. During interviews, they each identified their top oil stocks. These companies are listed below.
Underinvestment is good for oil industry and investors
Back on March 2, Sam Peters, a portfolio manager at ClearBridge Investments, provided this chart for this article that featured two of his energy stock selections:
The chart on the left shows that capital expenditures in the oil industry have increased during periods of low supply. The right side of this chart shows that capital expenditures fell last year due to declining inventories.
Oil producers had already been stung by the price collapse that began in 2014. But the action during early pandemic shutdowns in 2020 briefly took front-month contract prices below zero. Managers of oil companies have learned to avoid making capital spending commitments during times of high demand. The goal is to maximize cash flow and return cash to investors via dividends and share purchasebacks.
. Peters suggested two stocks in the previous article: EQT Corp.
which rose 50% from March 1 (the day before the article with his recommendations was published) through May 10, and Pioneer Natural Resources Co.
This rose by 4%. Those price increases exclude dividends — Pioneeer’s dividend yield is 6.96%.
“ We don’t need $100 oil. If oil stays above $80, these companies can still produce a lot of free cash that they can return to shareholders. “
— Simon Wong, energy sector research analyst at Gamco.
Oil prices have been volatile recently due to many factors, including Russia’s invasion in Ukraine which directly disrupted oil markets, China’s aggressive locking down of cities to stop new coronavirus outbreaks, and the reopening travel in many markets worldwide, including the U.S. These and other factors contributed to the rise in West Texas Intermediate crude oil’s price.
to swing as much as 13% from an intraday high ($111. 37 a barrel on May 5) to an intraday low ($98. 20 on May 11) this month alone.
Wong estimated that as 2022 began, world demand for crude oil ranged from 100 to 101 million barrels a day, while oil was being produced at a rate of about 98.5 barrels a day.
WTI closed at $105. 71 on May 11, rising from $75. 21 at the end of 2021.
Wong said new oil sources in the U.S. over the past 10 years had been mostly “short-term supply growth” because “you lose 50% to 70% in the first year” of a shale well’s operation.
” The U.S. could bring back supply,” he stated. However, this has not started yet because “shareholders” want operators to be more disciplined. Wong also mentioned the difficult political environment that is required for new pipeline construction, increased regulations, and difficulties borrowing from banks, all of which have contributed to an increase in the cost of developing new sources.
. Overall, Wong stated that the oil market is “bad news” for consumers and good news for investors. “We don’t need $100 oil. If oil stays above $80, these companies can still produce a lot of free cash that they can return to shareholders,” he added.
Favored oil stocks
Wong pointed to Canada as a friendlier market for U.S. investors because Canadian wells tend to last 20 to 25 years, by his estimate.
Wong prefers Suncor Energy Inc. among Canadian oil producers.
Meg Energy Corp.
Plays on free cash flow. Based on closing share prices on May 10 and consensus free-cash-flow estimates for the next 12 months among analysts polled by FactSet, Suncor’s estimated free cash flow yield is 18. 28%, while the estimate for Meg Energy is 25.68%. These are much higher than the consensus estimates of 5. 07% for the S&P 50 and 11. 15% for the S&P 500 energy sector.
. Exxon Mobil Corp. is one of his favorite U.S. producers.
for the long term, in part because of its large investment in offshore development in Guyana, with potential reserve development of 10 billion barrels, by his estimate.
.Lemonides said that there was a “great opportunity for investors to get in today” after a prolonged period when production investment was not economically feasible. His advice is to look beyond the current “gyrations” in the energy market because “the general direction of economic growth is likely to be strong.”
He listed three oil stocks that he sees as being heavily discounted now — all three emerged from pandemic-driven bankruptcies:
Whiting Petroleum Corp.
is a shale oil producer that trades for only three times the consensus earnings estimate for the next 12 months among analysts polled by FactSet. When the company filed for bankruptcy in April 2020, it had about $3 billion in debt. Market capitalization of the company is now only $2.9 billion. Lemonides believes that the company will earn more than analysts anticipate, even though its forward P/E ratio may be so low.
An offshore driller, which emerged from a pandemic-era bankruptcy. Its market capitalization is now $3.9 billion, and Lemonides said that the company’s fleet of drilling ships had been built at a cost of about $20 billion at a time when oil prices ranged between $85 and $100. He said that oil prices are back within that range and that a large percentage of the fleet is now back in work.
A different fleet is used to transport supplies to and from offshore drilling platforms. It also serves the offshore wind power generation sector. The company’s market cap is $835 million, which is about a third of what it would cost to replace its increasingly busy fleet, according to Lemonides.
Here’s a summary of forward P/E ratios (except for Tidewater, which is expected to post net losses in 2022 and 2023) and opinions of analysts polled by FactSet of the eight stocks discussed by Wong and Lemonides. The table uses Canadian stock tickers for Suncor and Meg Energy; share prices and targets are in local currencies:
|Company||Ticker||Forward P/E||Share “buy” ratings||Closing price – May 10||Consensus price target||Implied 12-month upside potential|
|Suncor Energy Inc.||
||6.5||62%||44. 71||51. 89||16%|
|MEG Energy Corp.||
||5.3||64%||18. 63||24. 93||34%|
|Exxon Mobil Corporation||
||9.4||45%||85. 02||98. 46||16%|
||18.1||88%||37. 89||50. 03||32%|
||16.3||79%||34. 30||46. 07||34%|
|Whiting Petroleum Corp.||
||3.2||56%||72. 53||100. 00||38%|
||25.5||100%||52. 40||71. 71||37%|
||#N/A||50%||20. 10||18. 50||-8%|
Click on the tickers for more about each company.
Read Tomi Kilgore’s detailed guide to the wealth of information for free on the MarketWatch quote page.
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