Energy

Merrill Lynch Very Cautious on Oil Stocks: 5 Defensive Picks to Buy Now

Lee Jackson

Published: February 5, 2020 7:15 am

When 2020 started, things were looking pretty solid for oil and the energy sector. Then to make things even spicier, a little geopolitical volatility was tossed into the mix when U.S. forces killed Iranian Major General Qasem Soleimani. That quickly spiked benchmark West Texas Intermediate crude close to $63 a barrel. In less than a month, though, the price has dropped a stunning 18%.

Despite the excitement over the electric vehicle revolution and the constant chatter about climate change, the world continues to need fossil fuels. The time may be right for some selective buying in the sector.

A new and comprehensive Merrill Lynch report makes the case that, just one month into 2020, the outlook for oil looks bleak with the possibility of a major China slowdown risking significant revisions to global growth. The analysts do cite the strong possibility of OPEC cutting production levels again, and with U.S. production slowing, a backstop may be put in place for oil prices around the $50 level.

Merrill said this regarding the prospects for oil:

We continue to believe slowing US oil growth is an overlooked aspect of the global macro outlook. We already expected a material slowdown in growth from 2019 into 2020, and further into 2021. With this latest oil correction, our expectation is that growth plans for many of the US oils slows even further.

The analysts suggested that investors look at more defensive companies in the sector, and these five stand out. All are rated Buy at Merrill and make sense for long-term growth investors with some risk tolerance.

ConocoPhillips

This stock may offer solid upside potential, and the company just gave investors a massive dividend increase. ConocoPhillips (NYSE: COP) explores for, produces, transports and markets crude oil, bitumen, natural gas, liquefied natural gas and natural gas liquids 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.

On Tuesday, the company reported profits of $0.76 per share, which was 37 cents lower than in the same quarter last year. Earnings of $0.80 per share for the quarter were anticipated by 19 analysts providing estimates. The company also reported revenue of $8.14 billion, which was higher than the estimated $7.71 billion.

Investors receive a 2.85% dividend. The Merrill price target for the stock is a massive $80, while the Wall Street consensus target is $72.63. ConocoPhillips stock closed Tuesday at $56.49, down almost 5% on the earnings results.

Exxon

This is a safer long-term play for conservative investors, and the energy giant is trading at stunning 10-year lows. Exxon Mobil Corp. (NYSE: XOM) is the world’s largest international integrated oil and gas company. It explores for and produces crude oil and natural gas in the United States, Canada, South America, Europe, Africa and elsewhere.

Exxon also manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and specialty products, and it transports and sells crude oil, natural gas and petroleum products. Note that Exxon has one of the highest paid American CEOs.

The company reported fourth-quarter results that did have some positive trends. The Merrill report noted this:

Fourth quarter 2019 reflects a difficult margin environment, amplified by the company’s greater leverage to chemicals/downstream vs the peer group. But nothing broken here. Cash-flow at a $32 billion run rate in a cyclical trough leaves the goal of doubling cash-flow by 2025 intact. We still see Exxon’s counter-cyclical investment underpinning rate-able dividend growth that separates it from other majors.

Exxon pays investors a 5.80% dividend. Merrill has a $100 price objective, and the consensus target price is just $83.92. Exxon Mobil stock closed at $59.97 on Tuesday.

This top mid/large-cap pick is down 20% from levels printed just three short weeks ago. Hess Corp. (NYSE: HES) is an exploration and production company that develops, produces, purchases, transports and sells crude oil, natural gas liquids (NGLs) and natural gas. It primarily operates in the United States, Denmark, Equatorial Guinea, the Joint Development Area of Malaysia/Thailand, Malaysia and Norway.

Hess remains one of only three energy companies on the Merrill Lynch US 1 list of top stocks, and the company has 80% of 2020 production hedged at $55 to $60. The analysts noted this after earnings for the fourth quarter were released and the stock got blasted yet again:

The 7% sell off following fourth quarter results looks wholly unjustified, with some confusion around guidance and unfounded PSC concerns. Management has addressed both, confirming strong cash flow and nothing to warrant a share price retreat to June 2019 levels. In a quarter with cash-flow and production beats we see the pull back as an enhanced opportunity.

Shareholders receive a 1.73% dividend. The $80 Merrill price target compares with a $65.50 consensus target and the most recent close at $57.67 a share.

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 Denver-Julesburg 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.

Merrill remains positive on the outlook for Noble and said this:

Noble energy is in the process of a reset in operating cash flow towards gas in Israel that trades at above two times US gas prices and in our view, will contribute more than $700 million to cash flow in 2020. Critically, a significant reduction (about $500 million) in capex following completion of Leviathan means the company will see one of the most significant rates of change in free cash flow while delivering top line growth of above 10%, with no growth necessary in the lower 48, in the current oil price environment. By our estimates, Noble can generate free cash flow of above $500 million which we expect to be deployed to a combination of debt reduction and share buy backs.

Shareholders receive a 2.41% dividend. Merrill has set a massive $41 price target. The consensus target is $28.73, and shares were last seen trading at $19.89.

Occidental Petroleum

This energy company made huge news last year with a Warren Buffett backed purchase of Anadarko Petroleum. Occidental Petroleum Corp. (NYSE: OXY) is an oil-levered multinational organization with principal business segments in oil and gas and in chemicals.

The oil and gas segment explores for, develops, produces and markets crude oil and natural gas, primarily in the U.S. Permian Basin, Colombia, Bolivia, Libya, Oman, Qatar and Yemen. Meanwhile, the chemicals segment manufactures and markets basic chemicals, vinyls and performance chemicals.

The shares have underperformed since the Anadarko acquisition was announced, but the investment case anchored by yield has not changed. The analysts note that the company has 50% of 2020 production hedged, and they pointed to the integration of Anadarko, where planned synergies, noncore asset sales and conglomerate cash flows provide downside protection through current commodity weakness.

Shareholders receive a massive 7.80% dividend. The Merrill price target is $80. That is well above the $54.85 consensus target. Occidental Petroleum stock closed most recently at $40.50.

Five top stocks all trading at super-low prices and, most importantly, offering investors perhaps the safest avenues for what many consider is a very contrarian bet. The large and reliable dividends that each pays will help investors if the sector stays flat. One thing is for sure: these stocks are at some of the best entry price points in years and could offer big-time upside in 2020 if crude prices rally back to just recent levels near $60.