While the macroeconomic outlook for commodities remains bullish, Zacks – Exploration and Production – International’s oil and gas industry is still far from normal, with the state of the Chinese economy the latest cause for concern. But a favorable landscape and a strong income proposition should translate into improved earnings and cash flow for upstream companies like Vermilion Energy (VETERINARY – Free report), Cairn energy (CRNCY – Free report), tallow oil (TUWOY – Free report), and VAALCO Energy (EGY – Free report).
Industry overview
The Zacks Oil and Gas – International E&P segment comprises companies operating primarily outside the United States, focused on the exploration and production (E&P) of petroleum and natural gas. These companies find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be further refined into products such as gasoline, fuel oil, distillate, etc. The economics of oil and gas supply and demand is the fundamental engine of this industry. In particular, a producer’s cash flow is primarily determined by the commodity prices realized. In fact, all E&P companies are vulnerable to historically volatile prices in energy markets. A change in achievements affects their yields on drilling stocks and causes them to alter production growth rates. These operators are also exposed to exploration risks when drilling results are uncertain.
3 key investment trends to watch in the oil and gas sector – International E&P Industry
Bullish outlook for commodities: Energy recovery is accelerating at a faster rate than expected as investors welcome the reality of a post-vaccine world. Mobility restrictions have been lifted and most sectors of the economy have reopened. In addition, the reduction in OPEC + production and supportive government policies add to this bullish narrative. As a result, the demand for oil and gas is booming. With Brent crude – the international benchmark – rallying at $ 75 a barrel and natural gas hitting seven-year highs amid macro tailwinds, E&P companies will benefit greatly for obvious reasons. Importantly, commodity prices appear to have entered a prolonged period of stability at levels where operators can generate free cash flow from their drilling activities.
Concerns about the health of the Chinese economy: The latest source of concern in the energy market is the state of China’s real estate sector and its economy in general. A possible default by China Evergrande – a heavily indebted real estate giant that appears unlikely to settle its interest payments – could affect the overall health of the world’s largest oil importer. This could reattach the Chinese economy, which could seriously disrupt the recovery in oil demand following COVID-19.
Lean cost structure: Energy companies have changed their approach to capital spending. Over the past few years, producers have worked tirelessly to keep costs to a minimum and seek innovative ways to produce more oil and gas. And that’s exactly what they managed to do by improving drilling techniques and securing favorable terms from besieged service providers. Additionally, thanks to operational efficiency, most E&P operators have been able to reduce unit costs, while the coronavirus-induced crude collapse has forced them to take a more disciplined approach to spending their capital. These actions could keep output stable (or slightly up) in the near term, but should preserve cash flow, support balance sheet strength, and help companies ultimately emerge stronger.
Zacks industry rankings reflect lukewarm outlook
Zacks Oil and Gas Industry – International E&P is a group of nine stocks within the larger Zacks Oil – Energy sector. It currently holds a Zacks Industry Rank # 128, which places it in the lowest 49% of over 250 Zacks industries.
The group’s Zacks Industry Rank, which is essentially the average of the Zacks Rank of all member stocks, indicates a difficult outlook for the near term. Our research shows that the top 50% of industries ranked by Zacks outperform the bottom 50% by a factor of more than 2 to 1.
Despite the industry’s weak near-term outlook, we’ll outline a few stocks you may want to consider for your portfolio. But it’s worth looking first at the industry’s shareholder returns and the current valuation.
Industry Outperforms Sector and S&P 500
Zacks’ oil and gas industry – International E&P has fared better than the larger Zacks oil and energy industry as well as the Zacks S&P 500 composite over the past year.
The industry grew 129% during this period compared to the larger sector’s increase of 40.3%. Meanwhile, the S&P 500 gained 33.2%.
One-year price performance
Current industry assessment
Since oil and gas companies are in debt, it makes sense to assess them on the basis of the EV / EBITDA (Company Value / Earnings Before Interest, Depreciation and Amortization) ratio. Indeed, the valuation measure takes into account not only equity, but also the level of indebtedness. For capital intensive companies, EV / EBITDA is a better valuation measure because it is not influenced by changes in capital structures and ignores the effect of non-cash spending.
Based on the 12-month enterprise value / EBITDA (EV / EBITDA) ratio, the sector is currently trading at 6.86X, significantly lower than the 15.59X of the S&P 500. However, it is higher than the EV / 12-month segment EBITDA of 4.84X.
Over the past five years, the industry has traded down to 35.07X, as low as 2.19X, with a median of 10.75X.
Enterprise value / EBITDA ratio (EV / EBITDA) over the last 12 months (last five years)
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4 Oil & Gas – International E&P Equities to Focus on
Tallow oil: Tullow Oil is a London-based hydrocarbon producer and explorer with a primary focus on Africa. The company’s significant positions in discovered and emerging pools and the emphasis on capital discipline should translate into a significant improvement in profitability. In particular, the operational excellence and technical expertise of the oil and gas researcher are very useful to him.
The Zacks 2021 consensus estimate for Tullow Oil shows earnings per share growth of 115.15% from 2020. The company is ranked Zacks Rank # 2 (Buy). Year-to-date shares of Tullow Oil have gained 37%.
Price and consensus: TUWOY
VAALCO Energy: Founded in 1985, VAALCO Energy’s production capacity is based off West Africa, where it is focused on growth through a combination of acquisitions and active drilling. The operator of the Gabonese offshore permit Etame is known for its operational excellence and its discipline in terms of costs, which should generate significant free cash flows at the price of the current striptease.
Zacks’ 2021 consensus estimate for VAALCO Energy, ranked No.2, indicates earnings per share growth of 437.50% from 2020. The company’s shares have gained 39% since the start of this year.
Price and consensus: EGY
Vermilion Energy: Vermilion Energy is an oil and gas exploration company with producing properties in Europe, North America and Australia. The company’s diversification on different continents gives it certain advantages over other upstream players. The energy explorer, with its unique portfolio of high margin, low decline assets, is currently focused on reducing costs and generating positive free cash flow.
The Zacks 2021 consensus estimate for Vermilion Energy shows earnings per share growth of 173.64% from 2020. The company is currently ranked Zacks Rank # 3 (Hold). Vermilion Energy shares have gained 66.9% so far this year.
Price and consensus: EFP
Cairn Energy: This upstream operator based in Edinburgh, UK, has key operations in Mexico outside of its home country, while its imminent entry into Egypt is expected to generate significant growth opportunities. Cairn Energy has adjusted its investment plans to prevailing market conditions resulting in strong operating cash flow. The company also has an active hedging program which provides additional protection against fluctuations in commodity prices.
Zacks 2021 Consensus Estimate for Cairn Energy shows earnings per share growth of 75% from 2020. Cairn Energy shares ranked 3rd in Zacks have lost 28.6% since the start of 2021.
Price and consensus: CRNCY
