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This year may be a turning point for the energy sector.
Shares of big oil producers, in particular, are due for a rebound, analysts say, and already they have shown signs of life after a terrible decade.
A rebound in oil prices is helping. The price of both West Texas Intermediate, the U.S. benchmark, and Brent crude, the international standard, continued to climb on Friday up another 2% in morning trading.
Oil prices have recovered from a steep drop last year after the pandemic forced businesses to close, choking off demand for fuels as people stayed home.
Crude prices fell more than 20% last year but are currently up for the new year, with WTI rising 6.5% and Brent up 7.2%.
Piper Sandler analyst Ryan Todd said conditions are shaping up for strong free cash flows at the oil majors this year, which could boost investor value.
He upgraded Chevron (CVX) to Overweight, the equivalent of a Buy rating, from Neutral on Friday. He also raised his price target on the stock to $113 from $108.
Chevron rose 1.8% on Friday and is up 8% for the year so far. The S&P 500 has added 1.5% this year and set another 52-week high on Friday.
Todd said Chevron has underperformed other oil majors by 20% since October.
The analyst said Chevron’s $14 billion to $16 billion annual capital spending plan—which is lower than previous spending—creates an average free cash flow yield of about 7% over the next two years, assuming WTI at $45 a barrel. (It’s at $51 now). That compares to a dividend yield of 5.73%.
“The company is well-positioned to ‘catch-up’ once reaching a potential strategic re-direction,” the Piper Sandler note said.
Todd also named Royal Dutch Shell (RDS.B) as his top European pick in the sector, on its exposure to liquified natural gas, which is near record peak prices thanks to a cold snap in Asia.
Todd already rates BP (BP), Royal Dutch Shell, and France’s Total (TOT) as Overweight and Exxon Mobil (XOM) as Neutral.
The price stability of oil is a risk factor to owning oil stocks, as investors experienced in the last year. A hastening of the transition from oil to renewable energy under a Democrat-controlled White House and Congress could also pressure the stocks,
Investors demand higher free cash flow yields to invest in legacy energy companies to account for this risk, Piper Sandler said.
The Organization of the Petroleum Exporting Countries, led by Saudi Arabia, and Russia have been working to stabilize the price of oil. Earlier this week, the Saudis surprised the market by voluntarily cutting production by 1 million barrels a day in February and March, while Russia will be allowed to slightly raise production.
Vaccines that promise to help stop the spread of the pandemic, allowing business to return to a more normal state, are also helping to stabilize oil.
Piper Sandler’s estimates are trending higher for the oil majors, except for Exxon, which Todd said is at a strategic crossroads.
“The crux of the issue is a squeeze between an oversized dividend, an expanded balance sheet, and a capital constrained budget that limits the pace at which it can improve its portfolio via its best-in-class project backlog,” Todd said about Exxon.
Shares of Exxon rose 1.3% on Friday and are up 10.9% this year.
Write to Liz Moyer at [email protected]
