If there is one sector that has frustrated investors this year, it has been energy, and with good reason. While West Texas Intermediate crude is only down about 8% this year, the SPDR S&P Oil & Gas Exploration & Production ETF is down a stunning 24%. This also comes on the heels of the International Energy Agency forecasting its strongest oil demand growth in two years. The Paris-based agency recently raised its 2017 estimate to 1.6 million barrels per day from 1.5 million on stronger-than-expected European and U.S. demand growth, as well as production declines in OPEC and non-OPEC countries.
In a new research report, the energy team at JPMorgan, they like others on Wall Street, focus on companies with solid free cash flow. They report noted this:
Investor frustration is building with exploration and production companies. While acronyms like “GOR” or gas/oil ratio have been used as a scapegoat, we think that a more important psychological shift is underway around capital allocation. E&Ps singular focus on net-asset-value is no longer being valued the same way in the market, while companies that have a more balanced free-cash-flow generation and capital allocation approach are outperforming.
Five top companies are now favored by the JPMorgan analysts, all are rated Overweight.
Anadarko Petroleum
This top company is still down a stunning 30% since January and is an outstanding Buy at current levels. Anadarko Petroleum Corp. (NYSE: APC) operates through three segments. The Oil and Gas Exploration and Production segment explores for and produces natural gas, oil, condensate, and natural gas liquids (NGLs). The other segments are Midstream and Marketing.
The company remains a solid value play, and despite less than stellar second-quarter results, many on Wall Street are very positive on the story for the rest of 2017 and beyond.
Most on Wall Street now expect lower production and capital spending from Anadarko. The reduced production mainly stems from an asset sale and the impact from the Colorado incidents earlier this year. The free-cash-flow deficit is $375 million for 2018 and $104 million for 2019.
Shareholders receive just a 0.4% dividend. JPMorgan has a $54 price target on the stock. The Wall Street consensus target is $60.40. Shares traded early Friday at $43.45.
Chevron
This integrated giant is a safer way for investors looking to stay or get long the energy sector, and it has big Permian Basin exposure. Chevron Corp. (NYSE: CVX) is a U.S.-based integrated oil and gas company with worldwide operations in exploration and production, refining and marketing, transportation and petrochemicals.
The company sports a sizable dividend and has a solid place in the sector when it comes to natural gas and liquefied natural gas. Some on Wall Street estimate the company will have a compound annual growth rate of over 5% for the next five years.
The company reported solid earnings for the second quarter, and analysts have noted that the Permian Basin remains a key source of capital flexibility, and it is a key issue behind their relative preference for Chevron versus some of the other majors. The JPMorgan report noted this:
For now, we assume that Chevron will be conservative on return of capital in a $50 per barrel Brent environment. We see minimal dividend increases of ~1c quarterly hike once every four quarters. We do not assume that the company would buy back stock as long as oil is less than $60 per barrel.
Chevron shareholders receive a 3.78% dividend. The JPMorgan price target is $123, and the consensus price objective is $115.19. Shares traded Friday at $114.35.
ConocoPhillips
This stock may offer investors solid upside potential and the company could start growing the dividends again. ConocoPhillips (NYSE: COP) explores for, produces, transports and markets crude oil, bitumen, natural gas, liquefied natural gas (LNG) and NGLs worldwide.
Conoco’s portfolio includes resource-rich North American tight oil and oil sands assets; lower-risk legacy assets in North America, Europe, Asia and Australia; various international developments; and an inventory of conventional and unconventional exploration prospects. Many Wall Street analysts feel the company can accelerate growth from a reloaded portfolio depth in the Bakken and Eagle Ford, and with visibility on future growth from a sizable position in the Permian.
Conoco has redefined its investment case with the highest free cash leverage to a recovery in oil prices among the big oil plays. Management has addressed key questions around portfolio resilience, and share buybacks have been prioritized over growth. The analysts noted:
Conoco has more than doubled the high-end of its original asset sale target ($16 billion versus $5-8 billion). Further, we have been encouraged by its continued strong execution on quarterly earnings. As the asset sales cash comes in the door and get directed toward debt paydown and buybacks, we think that this will start to remove some of the leverage overhang and help it re-rate to a more normal valuation versus peers.
Investors receive a 2.31% dividend. The $49 JPMorgan price target is less than the consensus target of $50.50. Shares were last seen at $46.25.
Canadian Natural Resources
This top Canadian play is JPMorgan’s top pick, based on a free-cash-flow yield basis. Canadian Natural Resources Ltd. (NYSE: CNQ) acquires, explores for, develops, produces, markets and sells crude oil, natural gas and NGLs. The company operates primarily in Western Canada; the U.K. sector of the North Sea; and Côte d’Ivoire, Gabon and South Africa in offshore Africa.
The company offers light and medium crude oil, primary heavy crude oil, Pelican Lake heavy crude oil, bitumen and synthetic crude oil. Its midstream assets include three crude oil pipeline systems and a 50% working interest in an 84-megawatt cogeneration plant at Primrose.
JPMorgan feels that the company’s metrics remain among the best in its research universe and noted this:
The company can cover sustaining capital and dividends at $40 per barrel with an
Improving balance sheet (2018 estimated ~3.1x net debt/CFO at $50 per barrel Brent), levers to pull if required and a good mix of growth/return of capital.
Shareholders receive a 2.65% dividend. JPMorgan has set its price target at $45. The consensus target is $38.34, and shares traded Friday at $32.90.
Noble Energy
Noble Energy Inc. (NYSE: NBL) is an independent energy company engaged in the acquisition, exploration and production of crude oil, natural gas and NGLs worldwide. Its principal projects are located in DJ Basin, Marcellus Shale, Eagle Ford Shale and Permian Basin of the United States, as well as in deepwater Gulf of Mexico, offshore Eastern Mediterranean and offshore West Africa. As of December 31, 2015, the company had approximately 1,421 million barrels oil equivalent of total proved reserves.
Noble sanctioned in February the phase 1 development of its giant natural gas discovery in Israel for a gross development cost of $3.75 billion with first sales expected in late 2019. The project will include the development of 9.4 trillion cubic feet gross from four producing wells, each capable of producing in excess of 300 million cubic feet per day.
The JPMorgan team noted:
We believe Noble’s diversified portfolio is poised to deliver differentiated growth at low capital costs as the company enters an attractive phase of its investment cycle, with the Delaware Basin poised to shift into development mode, supporting a double digit corporate oil growth objective in fiscal 2018 and fiscal 2019 from a low single digit clip in fiscal 2017.
Shareholders receive a 1.54% dividend. The JPMorgan price target is $31. The consensus target is $35.93. The stock was last seen at $26.00.
These five top energy stocks may offer long-term and value investors the best entry points since the lows of 2016. While the energy sector could remain volatile, buying at these levels certainly takes some of the risk premium out.
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