4 Stocks Worth Considering in the U.S. Upstream Industry
China is struggling with an economic slowdown and the pessimism has hit the crude demand outlook, which, in turn, has affected the Zacks Oil and Gas - Exploration and Production - United States industry. The possibility of more interest rate hikes in the near future to stem stubborn inflation adds to concerns. The market hasn't been kind to natural gas either, with the commodity trading considerably lower year to date. Although macro challenges are leading to some demand concerns, we think the space still has fuel left in the tank, especially for the operators that target growth opportunities and operating efficiency initiatives. We advise investors to focus on APA Corporation APA, Northern Oil and Gas NOG, Granite Ridge Resources GRNT and Evolution Petroleum Corporation EPM.
About the Industry
The Zacks Oil and Gas - US E&P industry consists of companies primarily based in the domestic market, focused on the exploration and production (E&P) of oil and natural gas. These firms find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be refined later into products such as gasoline, fuel oil, distillate, etc. The economics of oil and gas supply and demand is the fundamental driver of this industry. In particular, a producer’s cash flow is primarily determined by the realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. The E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - US E&P Industry
Weakening Crude Demand Outlook: While WTI oil, the U.S. benchmark, is currently trading near $90 a barrel, signals of incremental crude supplies and a deteriorating consumption outlook loom large on the commodity. Several factors, including prospects of loosening U.S. sanctions on Venezuela and Iran, stuttering growth in China and bearish economic data from Europe have clouded the outlook for medium-term energy usage. Coming to natural gas, the fuel slumped to a 25-year low in June 2020 but hit $10 per MMBtu for the first time since 2008 in August 2022. Now, it is hovering around a low $2.50-$2.70 thanks to weather woes and LNG export weakness.
Inflation Challenge: Most U.S. energy upstream companies have been experiencing rising costs in the form of increased expenses related to maintenance and inventory. The inflationary environment, together with supply-chain tightness, is not only pushing costs higher but also affecting capital programs. Apart from being hard to ignore, escalation in expenses is drowning out the benefits of any commodity price increase. In our view, the inflation-associated headwinds will continue to challenge growth and margin numbers with little chance of a quick resolution. This may lead to a rough road for oil/gas equities. In particular, worries about weaker energy demand due to the threat of recession might jeopardize the commodity’s ascent.
Focusing on Shareholder Returns: The sharp increase in crude prices last year allowed the upstream operators to deliver a solid financial performance. In particular, cash from operations is on a sustainable path, with revenues improving and companies slashing capital expenditures from the pre-pandemic levels amid higher commodity realizations. To put it simply, the environment of strong prices in 2022 helped the E&P firms to generate significant “excess cash,” which they intend to use to boost investor returns. In fact, more and more energy companies are allocating their increasing cash pile by way of dividends and buybacks to pacify the long-suffering shareholders.
Zacks Industry Rank Indicates Bearish Outlook
The Zacks Oil and Gas - US E&P industry is a 40-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #186, which places it in the bottom 26% 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 challenging 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 bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are becoming pessimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2023 have gone down 53% in the past year, the same for 2024 have fallen 32.7%.
Despite the dim 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 Underperforms S&P 500 & Sector
The Zacks Oil and Gas - US E&P industry has fared worse than the Zacks S&P 500 composite as well as the broader Zacks Oil – Energy sector over the past year.
The industry has gone down 8.6% over this period compared with the broader sector’s increase of 4.9%. Meanwhile, the S&P 500 has gained 13.3%.
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), the industry is currently trading at 6.32X, significantly lower than the S&P 500’s 13.31X. It is, however, above the sector’s trailing-12-month EV/EBITDA of 3.54X.
Over the past five years, the industry has traded as high as 12.74X, as low as 2.95X, with a median of 5.77X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
4 Stocks to Watch For
Granite Ridge Resources: It is a non-operated oil and gas exploration and production firm with a diverse portfolio spanning over 2,500 wells in key regions like Permian, Eagle Ford, Haynesville, DJ and Bakken. Instead of drilling its own wells, the company strategically invests in a portion of numerous high-quality wells operated by established public and private entities. This approach generates sustainable, risk-adjusted returns, ensuring value for investors, safety, and reliable energy solutions. With a strong balance sheet and promising shareholder returns, GRNT exhibits substantial growth potential.
The Zacks Consensus Estimate for this Zacks Rank #2 (Buy) upstream firm’s 2023 earnings has been revised 9.4% upward over the past 30 days. GRNT shares have lost 44.4% in a year. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: GRNT
APA Corporation: APA’s large, geographically diversified reserve base and high-quality drilling inventory guarantee multi-year production growth. The company’s increased focus on the Permian basin, known for its low cost and high internal rates of return, is another key driver. APA’ slew of discoveries in offshore Suriname, through its joint venture with TotalEnergies, is another positive catalyst for the company.
APA beat the Zacks Consensus Estimate for earnings in each of the last four quarters. The company has a trailing four-quarter earnings surprise of roughly 13.9%, on average. APA currently carries a Zacks Rank #3 (Hold). Meanwhile, The energy explorer has seen its shares edge up 0.9% in a year.
Price and Consensus: APA
Northern Oil and Gas: Northern Oil and Gas’ core operations are focused on three leading basins of the United States — the Williston, Permian and the Appalachian. The upstream operator employs a unique nonoperating business model, which helps it to keep costs down and increase free cash flow. Prioritizing returns to investors, NOG pays a 38 cents per share quarterly base dividend following a recent 3% hike.
Carrying a Zacks Rank of 3, the 2023 Zacks Consensus Estimate for Northern Oil and Gas indicates 11.6% earnings per share growth over 2022. NOG shares have gained 22% in a year.
Price and Consensus: NOG
Evolution Petroleum: Founded in 2003, Evolution Petroleum is an independent upstream operator engaged in the exploration, development and production of onshore oil and natural gas properties in the United States. Headquartered in Houston, TX, EPM is focused on the non-operated working interests in high-quality, long-life reserves in several properties across the nation. Evolution Petroleum is known for its prioritization of maximizing shareholder returns through buybacks and dividends.
EPM beat the Zacks Consensus Estimate for earnings in two of the last four quarters and missed in the other two. The Zacks Rank #3 company has a trailing four-quarter earnings surprise of roughly 11.6%, on average. Evolution Petroleum’s shares have lost 13.7% in a year.
Price and Consensus: EPM
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APA Corporation (APA) : Free Stock Analysis Report
Evolution Petroleum Corporation, Inc. (EPM) : Free Stock Analysis Report
Northern Oil and Gas, Inc. (NOG) : Free Stock Analysis Report
Granite Ridge Resources, Inc. (GRNT) : Free Stock Analysis Report
