After souring the sector for years, Wall Street is turning increasingly positive on energy with a growing number of analysts expressing optimism that the worst could be in the rearview mirror.
Evercore ISI’s Stephen Richardson is the latest Wall Street analyst to join the bull camp.
Richardson says the oil rally is supported by an assortment of catalysts, including a waning omicron wave; political unrest in Libya, protests in Kazakhstan, sabotage in Nigeria as well as the threat of war between Russia, a major energy producer, and Ukraine, a major energy transit hub.
During this time, Morgan Stanley oil strategist Martijn Rats raised the Brent oil price forecast to $100 for the third quarter of 2022, following $105 Goldman Sachs Upgrade earlier in the week.
So why $100? Morgan Stanley thinks $100/bbl is the level at which oil demand growth begins to slow, noting that during the 2011-2014 period, oil was equivalent to 4.5% of global GDP, GDP and at current consumption levels, Brent would need an average of $110 to achieve the same “share” of global GDP.
So what oil and gas stocks do these analysts recommend?
Richardson likes western (NYSE:OXY), Conoco Phillips (NYSE:COP) and Devon (NYSE: DVN) while GS loves Occidental, Apache Corp. (NYSE:APA), Anterior (NYSE:AR) and South West (NYSE:SWN) but cut Devon will stick to a strong outperformance and a reduced rise in valuations. Shares of DVN are up 162% over the past year.
Here are our own picks based on these recent recommendations.
#1. Conoco Phillips
Conoco Phillips (NYSE: COP) is a major shale player primarily involved in conventional and tight oil reservoirs, shale gas, heavy oil, LNG, oil sands and other production operations.
Last year, Bank of America COP shares upgraded to buy of Neutral with a price target of $67, calling the company a “cash machine” with the potential for accelerated returns.
According to BofA analyst Doug Leggate, Conoco seems “poised to accelerate cash returns at a faster and more meaningful pace than any “pure-play” E&P or oil major.
Leggate COP shares have returned to more attractive levels”but with a macro perspective different from that of the time [Brent] oil peaked near $70.”
But best of all, the BofA analyst believes the COP is highly exposed to a longer-term oil rally.
But BofA isn’t the only Wall Street bettor raving about COP.
In one note to customersRaymond James says the company’s stock price undervalues the flood of cash the oil and gas company is about to generate.
Well, it seems the analysts were right: Last month, Conoco unveiled its preliminary plans for 2022highlighting a three-tier program that could see the company return around $7 billion in cash to investors in 2022.
COP offers a redesigned shareholder return plan with:
1) Basic dividend of $2.4 billion (2.5% of market capitalization)
2) Variable dividend of 20 c/s in the next quarter (1.1% of current market capitalization, annualized)
3) $3.5 billion stock buyback (3.7% of market cap)
If this holds, this positions COP shareholders for a 7.3% payout with low production growth. COP forecasts a 36% increase in capital expenditure for the year (22% taking into account the Permian purchase), but production growth of only 3%. Indeed, Conoco is expected to bring about $7 billion in cash to investors in the coming year.
The company is also making smart investments, including its $9.5 billion all-cash acquisition of Royal Dutch Shell‘s (NYSE:RDS.A) in the Permian Basin and is also investing about $200 million in green projects to reduce its carbon emissions.
COP shares have returned 14.6% so far this year and are up 91.5% over 52 weeks.
#2. Devon BofA analyst Doug Leggate has an overweight rating on the energy sector and advised investors to focus on oil companies with the potential to increase free cash flow through consolidations or divestitures. other cost reduction measures, by appointing Devon Energy (NYSE: DVN), Pioneer of natural resources (NYSE:PXD), and EOG Resources (NYSE: EOG).
DVN stock was one of the best performing energy stocks thanks to strong earnings and continued cost discipline, including a variable dividend structure.
Related: When Will the United States Tap Its Huge Geothermal Energy Potential?
Following the merger with WPX Energy last year, the company announced fixed and variable dividends. Devon has adopted a variable dividend structure, which has gone down well with Wall Street. The stable share is indifferent, recently yielding less than 1%. But if the latest convertible payout is a sign of the future, shareholders could receive more than 7% in total.
Devon paid a regular dividend of $0.11/share and a variable dividend of $0.24/share during the quarter, implying an annualized yield of 5.5%. Additionally, the company has forecast a dividend yield of over 7% for 2021 if current trends continue, illustrating its commitment to returning more capital to shareholders in the form of dividends whenever cash flow permits.
Some Wall Street analysts have pointed to the potential for DVN to post a dividend yield of up to 8% by the end of the year. After all, this company is truly gushing with cash, with free cash flow increasing eightfold year-over-year to $1.1 billion in the third quarter of last year. Almost half of Devon’s price hedging from last year will pay off this year, which could give free cash flow another goose.
However, as noted by Goldman Sachs, DVN became quite expensive after the crazy rally, which could limit short-term gains. Devon sports a P/E ratio (TTM) of 27.6, almost triple the Energy sector’s 10.9 reading.
#3. APA Corp.
Shares of APA Corp. (NYSE:APA) rose after the company signed an agreement with the Egyptian government to invest at least $3.5 billion in research, development and production in the western desert of the country.
According to APA management, the agreement brings together 90% of gross production in a single concession and also refreshes the terms of existing development leases for 20 years.
Just last month, the Egyptian parliament approved an agreement to modernize and consolidate its production sharing contracts with the government.
APA’s joint venture with Chinese Sinopec is expected to increase gross capital investment by $235 million in Egypt in 2022 and increase Egypt’s gross oil production by 13-15%. The company says the joint venture will be entitled to recover nearly $900 million in overdue costs over five years beginning April 1, 2021.
Last year, APA announced a major oil discovery on its 1.4 million acre offshore territory in Suriname adjacent to Exxon Mobil Corp..’s (NYSE:XOM) historical discovery. APA said it made a world-class discovery at the Kwaskwasi-1 well located in the prolific Guyana-Suriname Basin, where it encountered 278 meters (912 feet) of net oil and volatile oil/gas condensate.
Bank of America Merrill Lynch presented Suriname’s perspective as a potential game-changer for APA:
“Suriname has the potential to reset the investment case,” Doug Leggate, veteran oil industry analyst at Merrill Lynch, said.
APA shares have gained 11.9% year-to-date and 80.9% in 12 months.
By Alex Kimani for Oilprice.com
More reading on Oilprice.com: