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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Top Three Rebound Stocks In The Permian Shale

With the oil and natural gas markets stabilized, at least for now, investors should begin considering which companies could emerge from the rubble of the oil price collapse to see their stock prices double or triple in the next few years.

At this stage, most oil companies are fairly valued based on their current earnings. But current earnings are not the only factor that matters when valuing a firm. Future earnings and efficiency improvements also matter. And on that front, there is a lot of disparity between different firms.

Efficiency is the new mantra for many firms across the oil patch, but it’s also easier said than done. Growing production at any cost is easy, and that’s what many firms have done in the last few years. Now that the good times are over, executives face the daunting task of making that production profitable on a sustained basis. In the Permian Basin there will be winners and losers, but three companies stand out as having exceptional opportunities over the next few years based on their early efforts at efficiency gains. Related: Why The Oil Rally May Well Be Over

Topping the list of interesting opportunities in the Permian Basin is one of the largest independent players, Occidental Petroleum (NYSE: OXY). OXY carries the size (~$60 billion market cap) and diversification while simultaneously having enough exposure to the Permian to make it an appealing opportunity for investors not interested in taking big risks.

OXY has one of the best balance sheets in the industry right now, which was highlighted in the firm’s last report. Management indicated that 2015 capex would probably come in below its initial expectations of $5.8 billion, and it highlighted progress on important cost cutting and efficiency measures.

Moreover, the firm pays a substantial dividend that actually looks safe at any reasonable forecast of near-term future oil process. The firm’s maintenance capex is low enough that it should be able to cover both capex and its $3 per share dividend without resorting to borrowing, all at low oil prices.

The firm reiterated its expectation that it would be cash flow neutral for 2015 at oil prices of $60 per barrel after paying its dividend. Well cost, drilling time, and other in situ site metrics all look set to improve by double digits through the year, and with the stock still down substantially year-over-year, there is likely to be a significant medium term opportunity here. Related: Peak Oil: Myth Or Coming Reality?

For contrarian investors, there are few better stocks in the oil business than Pioneer Natural Resources (NYSE: PXD). The firm has had its share of controversy with Wall Street lately, and for a $22 billion stock, the short interest in the name is pretty considerable at around 6 percent.

Still, like every other firm in the industry, PXD is taking steps to clean up its act and improve efficiency. The firm recently reported “clean” EPS and Cash Flow per share of -$0.03 and $2.42 respectively. This was below the Street consensus at $0.06.

Nonetheless, the play with PXD is a long-term one. The company has arguably the best Permian Basin long-term runway in the business with something on the order of 9.6 billion barrels of oil equivalent of net resource potential. The firm’s resource base is literally measurable in decades of production terms. While the company’s value then is in the ground, and it does cost money to get those resources out of the ground, in a deflationary well cost environment, that kind of long-term production pipeline actually gets more valuable over time, especially if costs deflate at a faster rate than the discount rate on PXD’s capital. Related: Renewable Energy Could Dominate Electricity Market In 15 Years

Finally, for investors willing to take on some risks, small-cap producer Ring Energy Inc (NYSEMKT: REI) is an interesting choice. The firm has only been public for a couple of years and its market cap is less than $500 million so it lacks the heft and track-record of many larger older firms. Still, the firm is operating profitably and executives have expressed confidence about the company’s ability to earn an acceptable rate of return even at $50 a barrel.

Management has been a big buyer of stock, and while the research around benefits from copying insider buying is mixed, management confidence in the future is never a bad sign for investors. Revenues are small as are EPS at REI, but given the size of the firm, its Permian footprint, and its operating efficiency, there is definite growth potential here and investors should take note.

By Michael McDonald of Oilprice.com

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