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Bullish Supply Fundamentals to Boost Oil & Gas US E&P Industry

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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.

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

  • Bullish supply and demand fundamentals recently pushed WTI oil prices above $65 a barrel. The U.S. crude benchmark rallied to the highes in almost six months, underpinned mainly by production cuts from the OPEC-led group of exporters, and drop in supply from Venezuela and Iran. The so-called OPEC+ deal (an alliance of OPEC, Russia and other non-member countries) is withholding output by around 1.2 million barrels per day until the end of June. U.S. sanctions against Venezuela and Iran also continue to tighten the commodity’s fundamentals. Signs of stable demand (contrary to previous expectations of slowing consumption), optimism over U.S.-China trade talks and the expiry of waivers granted to eight Iranian crude importers are other positives in the oil story. These themes not only put a floor beneath prices for the time being, but also are likely to aid the continuation of commodity’s recent gains, eventually to around $70 per barrel.
  • Meanwhile, natural gas prices are struggling to stay above the $2.5 per MMBtu mark with the onset of the injection season and continually growing production. The fundamentals of natural gas consumption continue to be favorable on growing demand by electrical utilities, booming exports to Mexico, large-scale liquefied gas export facilities and higher usage from industrial projects. However, record high production in the United States and expectations for explosive growth through 2020 means that supply will keep pace with demand. Therefore, prices are likely to trade sideways but for weather-driven movements. Currently trading around $2.6 per MMBtu, the fuel’s consumption is likely to be tepid in the near term amid moderate weather.
  • 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 surging 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 Indicates Positive Outlook

The Zacks Oil and Gas - US E&P is a 73-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #63, 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.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags Sector and 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 28.6% over this period compared to the S&P 500’s gain of 10.9% and broader sector’s decrease of 12%.

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 7.14X, lower than the S&P 500’s 11.29X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 4.90X.

Over the past five years, the industry has traded as high as 16.37X, as low as 4.15X, with a median of 7.85X.

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


Bottom Line

On Christmas Eve, WTI futures fell to 18-month lows of under $43 per barrel but have since recovered more than 50% of that value. The rebound has been primarily driven by the OPEC+ group restraining production. Importantly, the oil market appears well supported, especially through steady demand from Asian consumers like China and India. Bullish signals, including a possible extension of OPEC’s production cuts through the end of this year, are expected to back prices over the near-to-medium term.

Natural gas futures, meanwhile, are likely to remain sedate on surging supplies amid expectations of tepid demand.

We are presenting two stocks with a Zacks Rank #1 (Strong Buy) and two with Zacks Rank #2 (Buy) that are well positioned to grow.

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

Anadarko Petroleum Corporation (APC): Anadarko Petroleum is the biggest upstream player in Colorado’s DJ Basin and has attractive assets in the Delaware Basin in Texas. Over 30 days, the Woodlands, TX-headquartered company – carrying a Zacks Rank #1 – has seen the Zacks Consensus Estimate for 2019 increase 51.6% to $2.32 per share.

Price and Consensus: APC

Murphy Oil Corporation (MUR - Free Report) : Based in El Dorado, AR, Devon Energy explores and produces crude oil, natural gas and natural gas liquids (NGL) worldwide. Over 30 days, the Zacks Rank #1 company has seen the Zacks Consensus Estimate for 2019 increase 32.5% to $1.42 per share.

Price and Consensus: MUR

Apache Corporation (APA - Free Report) : Apache is one of the world's leading independent energy companies engaged in the exploration, development and production of natural gas, crude oil and natural gas liquids. Over 30 days, the Houston, TX-headquartered company – carrying a Zacks Rank #2 – has seen the Zacks Consensus Estimate for 2019 increase 32.1% to $1.03 per share.

Price and Consensus: APA

Continental Resources, Inc.(CLR - Free Report) : Based in Oklahoma City, OK, Continental Resources’ unconventional resources include the prolific Bakken Shale properties and the STACK and SCOOP plays in Oklahoma. Over 30 days, the Zacks Rank #2 company has seen the Zacks Consensus Estimate for 2019 increase 15.4% to $2.47 per share.

Price and Consensus: CLR


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