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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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Three Stocks Well Positioned For An Oil Price Rebound

It’s no surprise to any investor at this point that most oil company stocks are deeply depressed. But with oil prices a full $10 off their lows for the year, some of these beaten down stocks are starting to look like great deep value plays. Here are three firms that are worth a look for investors willing to bet on an oil price rebound.

Devon (DVN) – Before the oil price bust, Devon Energy was one of the biggest in the new breed of unconventional oil producers. The company remains one of the biggest firms in the space, but its market cap today is less than a third of what it once was. Devon’s attractive acreage in the Permian Basin gives the company exposure to the best of the U.S. shale fields. While nearly every other shale field in the U.S. is seeing declines in production, the Permian is proving to be among the most resistant thanks to attractive economics of production. Related: Oil Prices Up In Spite Of Crude Inventory Build

Devon has done a great job in optimizing its already efficient operations, and lowering capex. That has been reflected in the relative outperformance of the name. The composition of the firm’s production has been a significant tailwind for the stock, though there is a risk around this going forward. Devon has been increasing production whenever it could.

Devon’s stock held up reasonably well compared to many energy firms through about November of last year, but since that time the stock has collapsed, shedding roughly half of its value. That downward move was driven in part by an equity raise and a dividend cut done by Devon earlier this year. Devon started this year as a strong and compelling relative choice among energy stocks and it remains one of the best choices out there despite the deterioration in the macro environment. Devon has one of the lowest SIRs in the energy sector, it trades at less than 1X sales and less than 1.5X impaired book value, and its gross margins are among the highest in the industry. All of these factors are indicative of stock that should climb fast once investors decide the oil route has finally run its course. Related: How Leonardo DiCaprio’s Carbon Footprint Clashes With His Climate Claims

Marathon (MRO) – Devon is the “safe” play among deep value energy stocks, but it probably will “only” see ~150 percent upside once oil prices rebound. For investors looking for something more akin to 300 percent upside, Marathon (MRO) is a great choice to look at. MRO is definitely a little bit riskier than Devon – the balance sheet is not quite as strong, and the SIR reflects this. (For more on how to use SIR and other quantitative metrics to choose stocks, see this article).

But Marathon trades at an even deeper discount than Devon does – less than 0.5X impaired book value, despite having reasonably strong margins and debt metrics. Analysts remain optimistic on MRO and see its vast reservoir of reserves having significant value over time. The company had not traded at present levels for more than 10 years before the current oil bust began. Marathon is even cheaper now than it was at the height of the 2008 Recession when investors thought the world economy was collapsing and might take decades to recover. Related: Iran Slowly But Steadily Increasing Oil Market Share

Gastar (GST) - Finally for investors that want to focus on the riskiest but highest return segment of the market, tiny Gastar Exploration is an attractive choice. The microcap stock has fallen hard over the last year but could have 500 percent upside in an eventual rebound. The company has done an excellent job of monetizing assets to raise capital allowing it to focus on its core assets in the Oklahoma STACK play.

Production results continue to be strong for the firm, and if the price of oil starts to recover by the end of 2016 as many analysts expect, then Gastar will be a prime beneficiary. Even a modest increase from here in oil prices could make Gastar an acquisition target. The firm’s small size makes it acquirable for a wide range of competitors, and the STACK region is one of the best regions for shale production in the country. Between that and limited downside given the share price, Gastar is a great deep value choice for investors to consider.

By Michael McDonald of Oilprice.com

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