The market hasn't been kind to the Zacks
Oil and Gas - Exploration and Production - International industry in 2023 due to the overall weakness in the energy space and lower realizations along with uncertainties related to slowing global economic growth and inflationary pressure. 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 Kosmos Energy ( KOS Quick Quote KOS - Free Report) , Tullow Oil ( TUWOY Quick Quote TUWOY - Free Report) and Capricorn Energy . Industry Overview
The Zacks Oil and Gas - International E&P industry consists of companies primarily operating outside the United States and 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 realized commodity prices. In fact, all E&P companies are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns on drilling inventory and causes them to alter production growth rates. These operators are also exposed to exploration risks where drilling results are uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - International E&P Industry
Energy remains the worst S&P 500 sector this year. The space has witnessed a total return of -6.5% in 2023 so far against the S&P 500’s gain of around 12%. Even Saudi Arabia’s surprise decision to slash output by an additional one million barrels per day from next month could not spur “black gold.” With investors dumping risky assets in the wake of concerns about a slowing global economy, oil has broken below the $70 threshold on more than one occasion. It’s not any different for 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 last year. Now, it has gone below $2.50, on the expectation of comfortable temperatures and, therefore, lighter heating or cooling demand. Weakness in the Energy Space: Most energy companies (including the upstream operators) 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 their capital programs. Apart from being hard to ignore, escalation in expenses is also 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. Finally, what this means is that the central banks will be persistent with their aggressive policies to stem inflation. 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. Inflationary Pressure: The sharp increase in crude prices last year allowed 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. Substantial Shareholder Returns: Zacks Industry Rank Reflects Bearish Outlook
The Zacks Oil and Gas – International E&P industry is a nine-stock group within the broader Zacks
Oil - Energy sector. It currently carries a Zacks Industry Rank #236, which places it in the bottom 6% 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 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 59% since December, the same for 2024 have fallen 56% over the same timeframe. 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 Sector & S&P 500
The Zacks Oil and Gas - International E&P industry has fared worse than the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has fallen 34.5% over this period compared with the broader sector’s decrease of 9.4%. Meanwhile, the S&P 500 has gained 9.6%. 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 non-cash expenses.
On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, the industry is currently trading at 3.90X, significantly lower than the S&P 500’s 12.94X. However, it is higher than the sector’s trailing-12-month EV/EBITDA of 2.83X. Over the past five years, the industry has traded as high as 16.32X, as low as 2.19X, with a median of 6.51X. Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
3 Oil and Gas - International E&P Stocks to Watch
Tullow Oil: Tullow Oil is a London-based hydrocarbon producer and explorer, focusing mainly on Africa. TUWOY’s significant positions in discovered and emerging basins and focus on capital discipline should result in a noticeable improvement in profitability. In particular, the oil and gas finder’s operational excellence and technical expertise stand it in good stead. The 2023 Zacks Consensus Estimate for TUWOY indicates 33.5% year-over-year revenue growth. Tullow Oil carries a Zacks Rank #2 (Buy). TUWOY’s shares have lost 48.4% in a year. Price and Consensus: TUWOY
Capricorn Energy: Founded in 1981, Capricorn Energy’s productive capacity is based onshore Egypt, where it focuses on the lower cost rapid payback Western Desert. CRNCD’s attractive asset base and operational efficiency in the country provide it with a competitive advantage in an energy-hungry domestic and regional market. Valued at around $358.2 million, the 2023 Zacks Consensus Estimate for Capricorn Energy indicates 325.8% year-over-year revenue growth. CRNCD currently carries a Zacks Rank #3 (Hold). Capricorn Energy’s shares have lost 35.3% in a year. Price and Consensus: CRNCD
Kosmos Energy: Kosmos Energy is an oil and gas explorer focused on offshore Ghana, Equatorial Guinea and the U.S. Gulf of Mexico. The dual-listed (NYSE & London) company’s low-cost assets, growing free cash flow generation and solid balance sheet are likely to increase shareholder returns. The 2023 Zacks Consensus Estimate for Kosmos Energy indicates 8% earnings per share growth over 2022. #3 Ranked KOS shares are down 38% in a year. Price and Consensus: KOS