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5 Top Stocks to Capitalize on U.S. Upstream Industry's Bullishness

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With oil prices rebounding strongly in 2021, the underlying fundamentals of the Zacks Oil and Gas - Exploration and Production - United States industry has strengthened. As WTI prices revisit the $70s and natural gas consolidates above $3, upstream firms like Matador Resources Company (MTDR - Free Report) , Whiting Petroleum (WLL - Free Report) , Oasis Petroleum (OAS - Free Report) , Earthstone Energy (ESTE - Free Report) and SilverBow Resources (SBOW - Free Report) are likely to see their earnings and cash flow improve significantly.


About the Industry

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 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 affect their returns on drilling inventory and causes them to vary 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

Constructive Commodity Price Environment: The price of WTI crude — the U.S. benchmark — has staged a remarkable comeback since the depths of minus $38 a barrel last April. Recently nudging past $70 a barrel for the first time in more than two and a half years, 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 hit its highs for 2021 at $3.35 per MMBtu yesterday due to solid liquefied natural gas (“LNG”) export, strong deliveries to Mexico and the prospect of summer demand growth. The oil and gas price gains will greatly benefit the E&P companies like EOG Resources (EOG - Free Report) , Pioneer Natural Resources Company (PXD - Free Report) , etc. 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.

India’s COVID-19 Exposure Still a Concern: Oil consumption is facing new challenges from another wave of lockdowns and restrictions across large parts of India and Southeast Asia. Of particular concern is the still-prevalent (though declining) 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 infection, 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.

Focus on Aggressive Cost Management: 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, including the likes of Devon Energy, Diamondback Energy, Cabot Oil & Gas and Apache 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 Indicates Positive Outlook

The Zacks Oil and Gas - US E&P industry is a 44-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #116, which places it in the top 46% of 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 highly optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2021 have surged 159.4% year to date, the same for 2022 have more than doubled 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 - US 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 soared 102% over this period compared with the broader sector’s increase of 34.6%. Meanwhile, the S&P 500 has gained 40.7%.

One-Year Price Performance

 



 

Industr'y 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 11.35X, significantly lower than the S&P 500’s 17.44X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.80X.

Over the past five years, the industry has traded as high as 16.88X, as low as 2.91X, with a median of 8.96X.

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

 

 

5 Top Stocks to Buy Now

Whiting Petroleum: Whiting Petroleum’s core operations are focused in North Dakota's Williston Basin, with an enviable acreage of top-tier assets and a multi-year drilling inventory. The company’s continually improving drilling efficiency has driven down cash costs and led to attractive cash flows. Last year, Whiting Petroleum came out of a pandemic-forced bankruptcy with a much stronger, viable capital structure than the previous highly leveraged balance sheet. The company anticipates free cash flow in excess of $300 million for 2021 if oil averages $55 per barrel. With the commodity price picture looking upbeat, Whiting Petroleum currently looks well-positioned to meet its target.

Over 60 days, Whiting Petroleum has seen the Zacks Consensus Estimate for 2021 increase 134.9%. The company currently carries a Zacks Rank #1 (Strong Buy), while its shares have gained 108.4% over the past six months.

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

Price and Consensus: WLL

 


SilverBow Resources: A pure-play upstream operator in the Eagle Ford Shale in South Texas, SilverBow Resources is a natural gas-focused exploration and production company. It controls 165,000 net acres in the Eagle Ford and around 80% of its total output comprises natural gas. SilverBow Resources’ exposure to premium markets and focus on costs and margins should help it to benefit from rising natural gas prices.

Over 60 days, SilverBow Resources has seen the Zacks Consensus Estimate for 2021 increase 39.3%. The Zacks #1 Ranked company’s shares have gained 331.9% over the past six months.

Price and Consensus: SBOW

 


Oasis Petroleum: Oasis Petroleum’s asset base is primarily focused on the North Dakota and Montana regions of the Williston Basin, targeting the Bakken and Three Forks formations. The company’s quality asset base and post-restructuring balance sheet strength will support free cash flow generation and consequently, shareholder returns. Oasis Petroleum currently pays a quarterly dividend of 37.5 cents ($1.50 annualized), while it has announced a $100 million share repurchase program.   

Over 60 days, Oasis Petroleum has seen the Zacks Consensus Estimate for 2021 increase 525.1%. The company currently carries a Zacks Rank #1, while its shares have gained 154.6% over the past six months.

Price and Consensus: OAS

 


Earthstone Energy: Earthstone Energy has a strong footprint in the Midland basin of west Texas and the Eagle Ford trend of south Texas. This small-cap Permian-focused producer boast of low leverage, which is supported by substantial free cash flow. Importantly, by hedging roughly 88% of 2021 oil production, the company has significantly cut its exposure to the volatility in oil prices. Earthstone Energy’s attractive cash margins and low cost of production are other positives.

Over 60 days, the company has seen the Zacks Consensus Estimate for 2021 increase 187.5%. Earthstone Energy currently carries a Zacks Rank #2 (Buy). Meanwhile, the oil producer has seen its shares gain 166.7% over the past six months.

Price and Consensus: ESTE

 


Matador Resources Company: Matador Resources’ upstream operations are mainly concentrated in the Permian Basin and South Texas’ Eagle Ford shale — two of the most prolific U.S. shale plays. The company has come out strongly of the unprecedented challenges of 2020, enjoying a premium valuation relative to its industry peers. Matador Resources’ 2021 priorities include continued capital efficiency improvements and free cash flow generation that allowed the explorer to initiate a dividend earlier this year.    

The 2021 Zacks Consensus Estimate for #2 Ranked Matador Resources indicates 412.5% earnings per share growth over 2020. The company’s shares have gained 174.6% over the past six months.

Price and Consensus: MTDR

 



 

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