For years, searching for potentially rewarding oil and gas stocks during the ongoing energy crisis has pretty much felt like dumpster diving. The energy sector has been deeply out of favor over the past few years, with the Covid-19 pandemic only serving to make an already bad situation much worse.
But the worst appears to be in the rearview mirror as the energy sector continues to stage an impressive rebound as the global economy recovers from the ravages of the pandemic.
The energy sector is just coming off a bumper earnings season whereby it posted the biggest earnings beat of all 11 sectors of the U.S. economy.
With impressive bottom-line growth, many top energy names are returning more capital to shareholders in the form of share buybacks and dividends. Companies usually repurchase shares when they believe they are undervalued, a big positive for oil and gas bulls.
Meanwhile, Crude oil futures have rallied to their highest finish in months, with WTI price climbing above $65 for the first time in two months after OPEC+ stuck with plans to gradually ease production curbs, signaling confidence in the demand outlook.
With summertime fast approaching, here are 3 energy picks, with two being natural gas/LNG stocks bearing in mind that natural gas demand in the United States peaks in the wintertime, with a lesser peak during the summer.
#1. Apache Corp: Smart Hedging Strategy
Commodity price hedging is a popular trading strategy frequently used by oil and gas producers as well as heavy consumers of energy commodities such as airlines to protect themselves against market fluctuations. During times of falling crude prices, oil producers normally use a short hedge to lock in oil prices if they believe prices are likely to go even lower in the future, while heavy consumers like airlines do the exact opposite: Hedge against rising oil prices which could quickly eat into their profits.
However, hedging is far from a silver bullet that is guaranteed to protect anybody from volatile markets, something that many oil and gas producers are now feeling keenly.
Luckily, shale driller Apache Corp. (NYSE:APA) is one of the few companies that have been reaping the rewards of a smart hedging strategy.
During its Q1 2021 earnings transcript, Apache revealed that prescient changes to its natural gas hedging strategy right before the February freeze hit Texas brought the company an unexpected windfall in the form of a first-quarter realized gain of $147 million.
Apache said that its marketing team "generally seeks to maintain a balance between 'first of month' and 'gas daily pricing' for its U.S. natural gas portfolio using a combination of physical and financial contracts."
Apache entered into financial contracts in late January that increased exposure to "gas daily pricing" and lowered exposure to "first of month" pricing for the month of February. In essence, the company increased exposure to the spot or cash market, helping it to nab $4-plus for its Permian natural gas after spot electricity and gas prices spiked in mid-February to record highs thanks to the Texas freeze.
After fetching $4.61/Mcf for its Permian Basin natural gas in the first quarter, Apache now says it's stepping up prospecting activity and extending its exploration in Texas.
What happened might have been fortuitous, but Wall Street says the company is capable of replicating its latest success.
Analysts at Cowen & Co have boosted their earnings estimates for Apache mainly due to better realized pricing, but also because it "reflects greater exposure to daily pricing versus bid week."
Last year, Apache announced a major oil discovery at its 1.4-million-acre offshore Suriname tract adjacent to Exxon Mobil Corp.'s (NYSE: XOM) historic discovery. Apache says it has made a world-class discovery at the Kwaskwasi-1 well located in the prolific Guyana-Suriname Basin, where it encountered 278 meters (912 feet) of net oil and volatile oil / gas condensate pay.
Bank of America Merrill Lynch has touted the Suriname prospect as a potential game-changer for Apache:
"Suriname has the potential to reset the investment case," Merrill Lynch's veteran oil-industry analyst Doug Leggate has said.
Meanwhile, Seeking Alpha's author Michael Boyd says the company could be undervalued after the Suriname find.
APA stock is up 48.3% in the year-to-date.
#2. Cheniere Energy: Robust LNG Demand
At a time when the global energy market has been decimated by Covid-19, the LNG sector is one of the few that remain in decent shape. In 2020, natural gas demand fell 3%, relatively tame compared to declines by other fossil fuels thanks to natural gas being increasingly viewed as a bridge that will facilitate the transition from coal to renewable energy, especially in power generation. Even better: Liquified Natural Gas (LNG) managed to record 1% demand growth last year despite high levels of LNG market volatility with both extreme oversupply and extreme tightness during the course of the year.
After four tough quarters, Cheniere Energy (NYSE:LNG) is off to a strong start in 2021, thanks mainly to robust LNG demand. Cheniere, a leading pure-play LNG producer, has reported Q1 2021Q1 GAAP EPS of $1.54 per share beating Wall Street estimates by $0.76 while revenue of $3.09B (+14.0% Y/Y) beat by $210M.
Cheniere increased its full-year 2021 Consolidated Adjusted EBITDA guidance to $4.3-$4.6 billion and full-year 2021 Distributable Cash Flow guidance to $1.6 - $1.9 billion due primarily to improved market margins.
There's good reason to believe that Cheniere can maintain this trend over the long term.
With the global shift towards cleaner energy sources in full swing, LNG and natural gas bring the benefits of being the cleanest-burning hydrocarbon, producing half the greenhouse gas emissions and less than one-tenth of the air pollutants of coal. Consequently, LNG demand is expected to grow 3.4% per annum through 2035, with some 100 million metric tons of additional capacity required to meet both demand growth and decline from existing projects. Natural gas use in power generation capacity is expected to grow by an additional 300 GW by 2040, equivalent to 300 million tonnes of LNG, with the majority of that demand coming from Asia, especially China, India, and other Southeast Asia countries.
That marks natural gas/LNG as the only fossil fuel that will experience any kind of growth over the next two decades.
It's a major tailwind for Cheniere, given its already strong market share.
LNG stock has gained 36.0% YTD.
#3. Devon: Strong Earnings + Variable Dividends
After souring on the sector for years, Wall Street is increasingly turning positive on energy, with a growing number of analysts expressing optimism that the worst could be in the rearview mirror.
Bank of America is the latest to join the bullish camp and believes the Covid-19 vaccines will help return oil demand to normal levels in a matter of months.
A couple of months ago, BofA Analyst Doug Leggate projected that many oil and gas stocks will see significant upside in 2021 if Brent prices are able to rally to $55 per barrel or higher. With Brent prices constantly flirting with $70 per barrel, many shale drillers are now home and dry.
BofA has an overweight rating on the energy sector and has advised investors to focus on Oil companies with the potential to grow their free cash flows through consolidations or other cost reduction measures, naming Devon Energy (NYSE:DVN), Pioneer Natural Resources (NYSE:PXD), and EOG Resources (NYSE:EOG).
Turns out BofA was right on the money, with DVN stock surging 64.5% YTD thanks to strong earnings and continuing cost discipline, including a variable dividend structure.
Devon has reported better than expected Q1 earnings, with GAAP EPS of $0.32 beating by $0.10, marking the eighth beat in 10 quarters through revenue of $1.76B (-15.8% Y/Y) missed by $270 million. Cash from operations before changes in working capital clocked in at $719M vs. consensus of $700.9M while free cash flow of $260M beat the consensus of $206.2M.
But what's got investors particularly excited about this company is its continuing capital discipline.
"It is important to reiterate that we have no intention of allocating capital to growth projects until demand side fundamentals recover and it becomes evident that OPEC+ spare oil capacity is effectively absorbed by the world markets," CEO Richard Muncrief declared during the company's earnings conference call.
Devon has adopted a variable dividend structure, something that has gone down well with Wall Street.
Devon paid an $0.11/share regular dividend and a $0.24/share variable dividend during the quarter, implying an annualized 5.5% yield. Further, the company has forecast a dividend yield of more than 7% for 2021 if current trends hold, illustrating its commitment to return more capital to shareholders in the form of dividends whenever cash flows permit.
Some Wall Street analysts have pointed to the potential for DVN to sport a dividend yield of as high as 8% by year-end.
Another key attraction: Despite the rally, DVN stock remains relatively cheap.
By Alex Kimani for Oilprice.com
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