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5 Energy Stocks to Ride the Sector's Earnings Improvement

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With a market-thumping 24% return, 'Energy' was the top performing S&P sector in 2016. The incredible gains of last year stoked high expectations going into 2017.

Let's take a look at how oil and gas prices behaved during the first three months of this year.

Q1 Report Card: Prices Move Lower but Recover from Year-Ago Lows

Despite hope offered by the biggest oil deal in a decade and a new pro-fossil fuel administration in the White House, crude prices logged a loss of almost 6% for the first quarter as traders focused on the rising flood of U.S. shale-driven production. In other words, while OPEC's moves to trim output and rebalance the demand-supply situation has stabilized the market to a large extent, in the process it has incentivized shale drillers to churn out more. With the recent uptick in U.S. shale production putting more pressure onto the market, oil ended the first quarter at $50.60 per barrel, 5.8% lower than year-end 2016 prices.

Natural gas fared worse, dropping more than 14% in the Jan-Mar period, thanks to one of the mildest winters on record. A warmer winter translated into tepid requirement for the heating fuel and upended demand forecasts.

Despite the sequential fall, both oil and natural gas prices are in a sweet spot compared to the corresponding period of 2016. While crude slumped to a 12-year low, natural gas futures dropped to its worst level in almost 17 years.

Year-over-Year Gains Leads to Bullish Expectations

Ending the dismal trend from the past few quarters, a look back at the Q4 earnings season reflects that the overall results of the Oil/Energy sector finally turned the corner, driving the aggregate growth picture for the S&P 500 index.

The Oct-Dec 2016 period turned out to be a rather good one with the OPEC deal and extreme weather conditions engineering a hefty rise in oil and gas prices during the fourth quarter.

A historic OPEC production cut agreement, together with help from non-OPEC producers saw oil prices end the year at $53.72 a barrel, representing a gain of 11.4% sequentially and 45% for the year. Meanwhile, natural gas embarked on its own upward journey, with futures jumping around 25% just in the fourth quarter. Ending the year at $3.724 per million Btu (MMBtu) – up 59% from 2015 – the heating fuel was buoyed by a cold snap that translated into strong demand.

As a result, following 8 back-to-back quarters of earnings declines, analysts said that the sector was likely to get better in the fourth quarter and clock its first positive earnings growth after 2 years. With estimate revisions going up following OPEC’s Algeria grandstand, the Oil/Energy sector’s earnings were expected to improve handsomely from the fourth quarter 2015 levels.

True to the predictions, the sector came out swinging. For the sector components on the S&P 500 index, total Q4 earnings were up 17.1% on 2.0% higher revenues.

The picture looks rather encouraging for the upcoming Q1 earnings season as well. This is not surprising, considering that oil and gas both fell to multi-year lows in the year-ago period. In fact, the 'Energy' sector is set to turn around from a modest loss in the year-earlier period to improving positive earnings this quarter.

Importantly, as per our Earnings Outlook report, the aggregate dollar amount of earnings increase for the Energy sector is the highest of all 16 Zacks sectors, with Energy expected to earn a total of $7.7 billion in Q1 vs. a loss $1.6 billion in the year-earlier quarter. The top-line is likely to show an impressive growth of 32.4% from the first quarter 2016 levels.

How to Identify the Outperformers?

The encouraging figures suggest that there are a number of companies likely to beat our first quarter earnings estimates.

Investing in such companies can fetch handsome returns for investors. This is because a stock generally surges upon earnings beat.

But with a wide range of energy firms thronging the investment space, it is by no means an easy task for investors to arrive at stocks that have the potential to deliver better-than-expected earnings.

While it is impossible to be sure about such outperformers, our proprietary methodology - Earnings ESP - makes it relatively simple. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Earnings ESP is our proprietary methodology for identifying stocks that have high chances of surprising with their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.

You could further narrow down the list of choices by looking at stocks that have a favorable Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.

5 Stocks to Invest In

RPC Inc. (RES): Headquartered in Atlanta, GA, RPC provides a broad range of specialized services – including pressure pumping and coiled tubing – to independent oil and gas explorers throughout the U.S. Coming to the earnings surprise history, the company has an excellent track. It beat estimates in each of the last four quarters at an average rate of 16.64%.

Zacks Rank #2
Earnings ESP: +25.00%
Expected Earnings Release Date: Apr 26

NOW Inc. (DNOW): NOW Inc. is a distributor of energy and industrial products based in Houston, TX. Its surprise history is also good with the last four quarters averaging at 14.01%.

Zacks Rank #2
Earnings ESP: +17.39%
Expected Earnings Release Date: May 3

Emerge Energy Services L.P. (EMES): Structured as a master limited partnership, Southlake, TX-headquartered Emerge Energy Services is a provider of high-quality sand used for the hydraulic fracturing of oil and natural gas wells. The partnership’s expected EPS growth rate for 3 to 5 years currently stands at 20.00% –– comparing favorably with the industry growth rate of 12.90%

Zacks Rank #2
Earnings ESP: +14.29%
Expected Earnings Release Date: May 3

Range Resources Corp. (RRC): Based in Fort Worth, TX, Range Resources is an independent energy producer, with primary focus on the southwestern, Appalachian and Gulf Coast regions of the U.S. The company has topped earnings estimates in 3 of the last 4 quarters.

Zacks Rank #3
Earnings ESP: +47.06%
Expected Earnings Release Date: Apr 24

Southwestern Energy Co. (SWN - Free Report) : Spring, TX-based Southwestern Energy is a domestic oil and gas explorer with focus on the Arkansas side of the Arkoma Basin, Oklahoma, Texas and Pennsylvania. The 2017 Zacks Consensus Estimate for this company is 68 cents, representing a massive 6,941.18% earnings per share growth over 2016. Next year’s average forecast is 96 cents, pointing to another 40.12% growth.

Zacks Rank #3
Earnings ESP: +11.77%
Expected Earnings Release Date: Apr 27

Bottom Line

Riding on the recovery in oil and gas prices, there are certain energy companies that are primed to outperform the Zacks Consensus Estimate. They certainly hold the potential to make investors standout gains.

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