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.
Let’s take a look at the industry’s three major themes:
• 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 in April. Currently at a five-month high above $45, the oil market is expected to tighten through the remainder of 2020, supported by the OPEC+ cuts. Meanwhile, natural gas is nearing $2.5 per MMBtu and recently rallied to its highest in 2020 on the back of record cooling demand and expectations of continued hot weather, which is likely to translate into the burning of more fuel to feed higher electricity consumption for air-conditioning. The steady improvement in shipments of LNG for export and potential supply disruptions due to twin hurricane forecasts to hit the Gulf of Mexico are other positives in the natural gas story. The oil and gas price gains will greatly benefit the results of E&P companies for obvious reasons.
• Despite the amazing rally, oil prices are unlikely to move much higher as air travel remains seriously curtailed. Taking this into account, the International Energy Agency (“IEA”) revised down its estimates for 2020 global oil demand. The Paris-based organization now projects crude consumption to fall 8.1 million barrels per day to 91.1 million barrels per day in 2020. While the quantum of decrease is the largest in history, the newest figure represents 1400,000 barrels per day higher demand loss compared with last month’s report. IEA attributed the deterioration to the ongoing weakness in the aviation sector, which has virtually come to a standstill due to the coronavirus pandemic.
• 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 providers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs, while the ongoing collapse in crude has forced them to adopt a more disciplined approach to spending capital. These actions might decrease short-term production but are expected to preserve cash flow, support balance sheet strength and help the companies emerge stronger toward the end of this year.
Zacks Industry Rank Acknowledges Improving Outlook
The Zacks Oil and Gas - International E&P is an eight-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #101, which places it in the top 40% 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.
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 starting to get optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2020 have increased 4.8% in the two months, the same for 2021 have gone up 37%.
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 Lags Sector & S&P 500
The Zacks Oil and Gas - International 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 70.9% over this period compared with the S&P 500’s gain of 19.5% and the broader sector’s decrease of 29.2%.
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 2.95X, significantly lower than the S&P 500’s 13.03X. It is also below the sector’s trailing-12-month EV/EBITDA of 4.36X.
Over the past five years, the industry has traded as high as 72.35X, as low as 2.17X, with a median of 14.73X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio
While oil prices have rebounded from the coronavirus-induced lows in late April to more than $45 per barrel now, they are still around 30% below the pre-COVID-19 levels even as a surge in fresh coronavirus cases threatens to derail the commodity’s recovery. As long as the coronavirus outbreak continues unabated (as is now the case in Latin America and India), there will be pressure on the demand side of the equation.
However, slowing production growth in the shale region and continued OPEC+ cuts are likely to provide some tailwinds to the outlook. Finally, greater financial discipline practiced by the energy companies has raised expectations that supply growth could slow down sooner or later.
It’s quite clear that the low-cost, nimbler international E&P operators with operational efficiencies are more likely to survive the downturn. The key to success would be the ability to adapt to market conditions and change drilling activity levels accordingly.
Considering the above-mentioned factors and the industry’s current dynamics, we are presenting four stocks with a Zacks Rank #3 (Hold) that investors may currently retain in their portfolio.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Kosmos Energy Ltd. (KOS - Free Report) : Kosmos Energy is an oil and gas explorer focused on offshore Ghana, Equatorial Guinea and U.S. Gulf of Mexico. Over 30 days, the dual-listed (NYSE & London) company has seen the Zacks Consensus Estimate for 2020 improve 14.9%.
Tullow Oil plc (TUWOY - Free Report) : Tullow Oil is a London-based hydrocarbon producer and explorer with the main focus on Africa. The stock has an expected earnings growth of 84.2% for 2020.
Vermilion Energy Inc. (VET - Free Report) : Vermilion Energy is an oil and gas explorer with producing properties in Europe, North America and Australia. Over 30 days, the company has seen the Zacks Consensus Estimate for 2020 improve 2.4%.
Cairn Energy plc (CRNCY - Free Report) : This Edinburgh, UK-based upstream operator has key operations in Senegal apart from its home country. Over 30 days, Cairn Energy has seen the Zacks Consensus Estimate for 2020 improve 74.1%.