The Zacks Oil and Gas - Exploration and Production - United States industry appears on track for substantial gains as oil and natural gas prices continue to move higher. Building on this bullish narrative, upstream firms like Civitas Resources CIVI, SM Energy SM, Oasis Petroleum OAS, Centennial Resource Development CDEV and Laredo Petroleum LPI have lots of upside and are likely to see impressive revenue and cash flow growth.
About the Industry
The Zacks Oil and Gas - US E&P industry consists of companies primarily based in the domestic market, 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 the realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. The E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.
3 Key Investing Trends to Watch in the Oil and Gas - US E&P Industry
Energy Prices Show No Signs of Letting Up: Last week, the price of oil briefly rose above $100 a barrel for the first time since 2014 amid Russia’s launch of military operations in Ukraine. As it is, crude prices had already been gaining strength prior to the attack because of a demand uptick owing to the reopening of economies and a rebound in activity. The situation is particularly complex on the natural gas front, with Russia being the world's largest producer of the fuel. Significantly, some 70% of Russian natural gas supplies are purchased by European countries that have no option to substitute a major part of it. The worldwide uncertainty imposed by Kremlin’s aggression pushed U.S. natural gas prices toward the $5 per MMBtu. In other words, macro as well as geopolitical tailwinds have driven the most bullish sentiments in the energy market in years and the E&P companies should greatly benefit for obvious reasons.
Shale Drillers Maintain Production Discipline: Unlike previous occasions, this time the U.S. shale operators have been reluctant to turn the tap on production despite the rise in oil realizations. Most of them were forced to dial back output in response to the COVID-induced decimation in demand and prices. Even with the steep rise in the price, the companies seem to be in no hurry to boost output. Finally, learning their lesson, shale operators are focusing primarily on improving cost and increasing free cash flow rather than looking at boosting production. While oil at $90 is profitable for almost all shale entities, the industry, for its part, is sticking to the mantra of capital discipline and sustainable production. According to the weekly data provided by Houston-based Baker Hughes, the last time that WTI crude traded at these levels, some 1,600 oil rigs were operational. Now, it’s just around 520, which is proof of the wariness on the part of the producers to raise output too quickly.
Sustainable Cost-Cutting Efforts: The energy companies have changed their approach to spending capital. Over the past few years, 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 providers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs, while the coronavirus-triggered destruction in crude forced them to adopt a more disciplined approach to spending capital. These actions might constrain short-term production but are expected to preserve cash flow, support balance sheet strength and help the companies emerge stronger. In particular, cash from operations is on a sustainable path as revenues improve and companies slash capital expenditures from the pre-pandemic levels amid sharply higher commodity prices.
Zacks Industry Rank Indicates Positive Outlook
The Zacks Oil and Gas - US E&P industry is a 41-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #71, which places it in the top 28% 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 fairly strong 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 top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are highly optimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2022 have surged 250% in the past year, the same for 2023 have risen 120.9% over the same timeframe.
Considering the encouraging dynamics 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 the current valuation first.
Industry Outperforms Sector & S&P 500
The Zacks Oil and Gas - US E&P industry has fared better than the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.
The industry has gone up 76% over this period compared with the broader sector’s increase of 32.6%. Meanwhile, the S&P 500 has gained 13.9%.
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), the industry is currently trading at 8.38X, significantly lower than the S&P 500’s 14.11X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.06X.
Over the past five years, the industry has traded as high as 16.37X, as low as 2.90X, with a median of 7.62X.
Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)
5 Top Stocks to Buy Now
Centennial Resource Development: A pure-play Permian Basin oil producer, CDEV has an impressive acreage position in the Delaware Basin, where it holds over 73,500 net acres and approximately 15 years of economic inventory. Reflecting its strong leverage to the commodity price uptick, Centennial Resource Development expects to generate free cash flow in excess of $400 million in 2022, to go with oil production growth of 10-15%.
Over 60 days, Centennial Resource Development has seen the Zacks Consensus Estimate for 2022 increase 18.9%. The Zacks Rank #1 (Strong Buy) CDEV’s shares have gained some 104.6% in a year. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: CDEV
Civitas Resources: Formerly known as Bonanza Creek Energy, Civitas Resources was formed out of the merger between Bonanza Creek Energy and Extraction Oil & Gas. CIVI’s high-quality asset base, disciplined capital allocation and fortress balance sheet allows it to maintain an attractive long-term cash flow profile. The pure-play DJ Basin operator also pays out a quarterly dividend of 46.25 cents per share with a peer-leading yield of nearly 4%.
Sporting a Zacks Rank of 1, the 2022 Zacks Consensus Estimate for CIVI indicates 117.3% earnings per share growth over 2021. Civitas Resources’ shares have gained approximately 50.7% in a year.
Price and Consensus: CIVI
SM Energy: SM Energy is an oil and gas explorer in North America. The company’s top-tier, balanced and diverse portfolio of proved reserves, as well as development drilling opportunities is expected to create long-term value for its shareholders. Given SM Energy’s increasing focus on crude oil, specifically in the Permian Basin and Eagle Ford regions, we believe that the company is in a good position to capitalize on strong realizations in the coming days.
The 2022 Zacks Consensus Estimate for SM indicates 246% earnings per share growth over 2021. The company currently carries a Zacks Rank #1. Meanwhile, the upstream player has seen its shares gain 128.6% in a year.
Price and Consensus: SM
Laredo Petroleum: Another Permian-focused operator, LPI has approximately 166,000 net acres in the basin, with eight years' worth of drilling inventory. Laredo Petroleum focuses on growth through a combination of acquisitions and active drilling in the lucrative play. The company’s high-margin production growth and ability to generate significant free cash flow has allowed it to reduce leverage ratio. LPI also runs a disciplined hedging program that offers some downside protection.
The 2022 Zacks Consensus Estimate for Laredo Petroleum indicates 226.4% earnings per share growth over 2021. Laredo Petroleum currently carries a Zacks Rank #2 (Buy). Meanwhile, the hydrocarbon producer has seen its shares increase around 122.1% in a year.
Price and Consensus: LPI
Oasis Petroleum: One of the leading Bakken players, Oasis Petroleum’s production growth is likely to benefit from its top-tier acreage (497,400 net acres) in the Williston Basin. In 2020, OAS came out of a pandemic-forced bankruptcy with a much stronger, viable capital structure than the previous highly leveraged balance sheet.
The 2022 Zacks Consensus Estimate for #2 Ranked OAS indicates 169.3% earnings per share growth over 2021. Oasis Petroleum’s shares have gained some 132.8% in a year.
Price and Consensus: OAS
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