With oil prices rebounding strongly in 2021, the underlying fundamentals of the Zacks Oil and Gas - Exploration and Production - International industry has strengthened.
As Brent prices approach the $70s, upstream firms like Vermilion Energy (VET), Kosmos Energy (KOS), Cairn Energy (CRNCY) and Tullow Oil (TUWOY) are likely to see their earnings and cash flow improve significantly.
The Zacks Oil and Gas - International E&P industry consists of companies based outside the United States and Canada focused on exploration and production (E&P) of oil and natural gas. These firms are engaged in finding hydrocarbon reservoirs, drilling oil and gas wells, and producing and selling these materials to be refined later into products such as gasoline. The economics of oil and gas supply and demand is the fundamental driver of the E&P industry. In particular, a producer’s cash flow is primarily determined by the realized commodity prices.
3 Key Investing Trends to Watch in the Oil and Gas - International E&P Industry
Oil & Gas Price Gains Enhance Market Stability: The price of Brent crude — the international benchmark — has staged a remarkable comeback after skidding to a more than two-decade low of $15.98 per barrel last April. Currently nearing $70, the oil market is expected to tighten throughout 2021, supported by the OPEC+ cuts and an earlier-than-expected pickup in the commodity’s demand on the back of vaccine rollouts. Meanwhile, natural gas — up 16% in 2020 for its biggest annual gain in four years — is nearing $3 per MMBtu due to growing liquefied natural gas (“LNG”) export and strong deliveries to Mexico amid flat production. The oil and gas price gains will greatly benefit the results of E&P companies for obvious reasons. Importantly, commodity prices appear to have entered a protracted period of stability at levels where the operators can generate free cash flow through their drilling activities.
COVID-19 Resurgence in India to Hurt Demand: Oil consumption is facing new challenges from another wave of lockdowns and restrictions across large parts of Asia such as India, Japan and Thailand. Of particular concern is the surging pandemic in India — the world's third-largest crude importer and consumer — that is likely to slow the oil demand recovery. Several states of India have announced restrictions on consumer and business activities as a result of the virus explosion, which has reduced the country’s fuel consumption. While global oil usage assumptions have strengthened due to a confluence of tailwinds, India’s coronavirus crisis might prevent the commodity’s quicker price rebound.
Producers Continue Their Pledge to Cut Costs: The energy companies have changed their approach to spending capital. Over the past few years, producers worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. And they managed to do just that by improving drilling techniques and extracting favorable terms from the beleaguered service providers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs, while the coronavirus-induced collapse in crude has forced them to adopt a more disciplined approach to spending capital. These actions might keep short-term production flat (or marginally up) but are expected to preserve cash flow, support balance sheet strength and help the companies eventually emerge stronger.
Zacks Industry Rank Acknowledges Upbeat Outlook
The Zacks Oil and Gas – International E&P industry is an 8-stock group within the broader Zacks Oil - Energy sector. It currently carries a Zacks Industry Rank #119, which places it in the top 47% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates improving near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic on this group’s earnings growth potential. While the industry’s earnings estimates for 2021 have increased 140.4% in the past year, the same for 2022 have risen 110.7% over the same timeframe.
Considering the encouraging near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas - International E&P industry has fared better than the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has surged 67.2% over this period compared with the broader sector’s increase of 36.4%. Meanwhile, the S&P 500 has gained 43.2%.
One-Year Price Performance
Industry’s Current Valuation
Since oil and gas companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 8.62X, significantly lower than the S&P 500’s 17.04X. However, it is above the sector’s trailing-12-month EV/EBITDA of 5.76X.
Over the past five years, the industry has traded as high as 35.07X, as low as 2.19X, with a median of 11.75X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Oil and Gas - International E&P Stocks to Focus On
Vermilion Energy: Vermilion Energy is an oil and gas explorer with producing properties in Europe, North America and Australia. The company’s diversification across different continents provides it with certain advantages relative to the other upstream players. The energy explorer is currently focused on cost reductions and positive free cash flow generation.
The 2021 Zacks Consensus Estimate for Vermilion Energy indicates 103.35% earnings per share growth over 2020. The company currently carries a Zacks Rank #3 (Hold). Vermilion Energy’s shares have gained 125.6% over the past six months.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Price and Consensus: VET
Tullow Oil: Tullow Oil is a London-based hydrocarbon producer and explorer with the main focus on Africa. The company’s significant positions in discovered and emerging basins and focus on capital discipline should result in noticeable improvement in profitability.
The 2021 Zacks Consensus Estimate for Tullow Oil indicates 109.09% earnings per share growth over 2020. The company also carries a Zacks Rank of 3. Tullow Oil’s shares have gained 145.7% over the past six months.
Price and Consensus: TUWOY
Kosmos Energy: Kosmos Energy is an oil and gas explorer focused on offshore Ghana, Equatorial Guinea and the U.S. Gulf of Mexico. The dual-listed (NYSE & London) company’s low-cost assets, growing free cash flow generation and solid balance sheet are likely to increase shareholder returns.
The 2021 Zacks Consensus Estimate for #3 Ranked Kosmos Energy indicates 110.94% earnings per share growth over 2020. The company’s shares have gained 108.4% over the past six months.
Price and Consensus: KOS
Cairn Energy: This Edinburgh, UK-based upstream operator has key operations in Senegal apart from its home country. Cairn Energy has adjusted its capital plans to the prevailing market conditions resulting in strong operating cash flows. The company also possesses an active hedging program that provides further downside protection from commodity price fluctuations.
The 2021 Zacks Consensus Estimate for Cairn Energy indicates 32.50% earnings per share growth over 2020. The Zacks #3 Ranked Cairn Energy’s shares have lost 7% over the past six months.
Price and Consensus: CRNCY
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