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Oil & Gas US E&P Outlook: Bullish Signals Abound

Nilanjan Choudhury

The Zacks Oil and Gas - US E&P industry consists of companies based in the United States 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.

Some of the prominent stocks in this industry are Apache Corporation (APA), Cabot Oil & Gas Corporation (COG), Noble Energy Inc. (NBL), Diamondback Energy, Inc. (FANG) and Cimarex Energy Co. (XEC).

Let’s take a look at the industry’s three major themes:

 

  • Oil posted 34.5% rise last year - the biggest annual increase since 2016. In particular, WTI, the U.S. benchmark, jumped nearly 11% in December, aided in part by the agreement on a phase one trade deal between the United States and China. The development – coming after months of wrangling – was seen to prop up the oil demand outlook on the back of revival in global economic growth. The recent ‘formal signing’ of the agreement is set to further strengthen the oil consumption levels as Beijing has pledged to purchase a massive $50 billion in American energy products over the next two years. Also boosting oil, the OPEC+ group is cutting output by as much as 500,000 barrels per day from Jan 1 for three months.

 

  • Meanwhile, no major commodity had a worse 2019 than natural gas. The fuel endured a torrid year, registering its worst annual decline since 2014. Prices tumbled more than 25% last year, falling to multi-year lows of around $2.1 per MMBtu in between, as buyers fled the market over growing worries about record output and concerns of an ongoing supply glut. With output from shale formations swamping the market, there is little room for prices to improve meaningfully from their current levels of around $2.2 per MMBtu. Operators in oil-dominated shale basins like the Permian, Eagle Ford and North Dakota are also struggling with significant natural gas flaring - a largely unwanted derivative that emerges alongside crude production in the region.

 

  • Over the past few years, energy 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 producers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs and live within their cash flows. All of these factors, together with production growth and capital discipline have resulted in healthy free cash flows. With cash generation expected to remain robust even at relatively low oil prices, there is strong potential for greater return of capital to shareholders through dividend growth and stock buybacks.

 

Zacks Industry Rank Paints a Rosy Pictures

The Zacks Oil and Gas - US E&P is a 61-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #64, which places it in the top 25% 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 bullish 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.

Taking into consideration the positive 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 Lags Sector & S&P 500

The Zacks Oil and Gas - US E&P industry has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 27.2% over this period compared to the S&P 500’s gain of 23.6% and broader sector’s decrease of 5.6%.

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 8.43X, lower than the S&P 500’s 12.12X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.06X.

Over the past five years, the industry has traded as high as 17.27X, as low as 4.96X, with a median of 8.41X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

 

 

 

Bottom Line

The trade deal should help prop up the demand outlook for oil while OPEC’s deeper supply cuts are likely to push the market back into supply deficit. Moreover, the growth rate of U.S. shale oil production is set to slacken substantially in 2020 on reduced capital availability. Finally, greater financial discipline practiced by the energy companies have raised expectations that supply growth could slow down sooner than later.

With the abovementioned catalysts set to provide near-term upside, we are presenting four stock with a Zacks Rank #2 (Buy) that are well positioned to gain.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Concho Resources Inc. (CXO): Concho Resources focuses on growth through a combination of acquisitions and active drilling in the lucrative Permian Basin spread over west Texas and New Mexico.The Midland, TX-based company has an expected earnings growth of 47.4% for this year.

Price and Consensus: CXO

 

 

Devon Energy Corporation (DVN): This Oklahoma City-based upstream operator’s oil and gas operations are mainly concentrated in the onshore areas of North America, primarily in the United States. Devon Energy has an attractive expected earnings growth of 47.1% for this year.

Price and Consensus: DVN

 

 

EOG Resources, Inc. (EOG): EOG Resources’ operations are spread across the United States, China and Trinidad. Over 30 days, the Houston, TX-headquartered company has seen the Zacks Consensus Estimate for 2020 increase 3.2%.

Price and Consensus: EOG

 

Pioneer Natural Resources Company (PXD): Pioneer Natural Resources is an independent oil and gas explorer with producing properties mainly in the Permian Basin. The Irving, TX-based company has an expected earnings growth of 15.3% for this year.

Price and Consensus: PXD

 

 

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Cimarex Energy Co (XEC) : Free Stock Analysis Report
 
Pioneer Natural Resources Company (PXD) : Free Stock Analysis Report
 
Noble Energy Inc. (NBL) : Free Stock Analysis Report
 
Diamondback Energy, Inc. (FANG) : Free Stock Analysis Report
 
EOG Resources, Inc. (EOG) : Free Stock Analysis Report
 
Devon Energy Corporation (DVN) : Free Stock Analysis Report
 
Concho Resources Inc. (CXO) : Free Stock Analysis Report
 
Cabot Oil & Gas Corporation (COG) : Free Stock Analysis Report
 
Apache Corporation (APA) : Free Stock Analysis Report
 
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