WTI crude oil, a global benchmark, is up 30% so far this year.
Spencer Platt/Getty Images
Oil stocks have hit a wall, but the price of the commodity should move higher soon. And that would be good for the stocks.
The year got off to a fast start. The stocks soared on investor expectations that the reopening would fuel demand for oil and gas. In the past month, though, they’ve struggled—dogged first by fears of the Covd-19 outbreak in India and now by the Colonial Pipeline shutdown on the East Coast.
Stock prices and oil prices have essentially mirrored each other. Take, for example, Energy Select Sector SPDR Fund (ticker: XLE) and WTI crude oil.
The fund is up 36% year to date, touching a more than one-year high of $53 a share three times—only to promptly fall. Since early March, the price has been essentially flat.
WTI crude oil, a global benchmark, is up 30% so far this year but has been stuck at around $64 a barrel—also since early March. And the price has made a reach for $66, but just can’t hold on.
Oil prices, though, could be heading higher, and that should mean higher prices for oil stocks. Here’s why:
Higher oil prices mean stronger revenue growth for oil producers and even stronger earnings growth. That’s because the producers have high operating leverage; their costs are largely fixed, so when revenues grow, costs like depreciation remain constant and profits grow faster than revenue.
Oil stocks are positioned to benefit from higher earnings because their valuations don’t necessarily reflect the full profit strength; the average energy stock on the S&P 500 trades at an 8% lower multiple of forward earnings than the average on the entire index.
With all that in mind, analysts at Siebert Williams Shank have lifted their oil price estimates by 10.5% to $63 and 18% to $65 for 2021 and 2022, respectively. To be sure, crude is already trading above its pre-pandemic level, but strong economic demand could boost the price above $70 a barrel.
“There is strong momentum behind commodity prices with the weakening U.S. dollar and increasing inflationary pressures,” writes Gabriele Sorbara, analyst at Siebert Williams Shank.
A weakening U.S. dollar would make global purchases of oil, which trades in dollars, less costly and would raise demand. And the dollar could certainly weaken as the globe recovers from the pandemic and investors move out of safe haven assets.
And Sorbara upgraded eight stocks and lifted 16 price targets. Three of the upgrades:
Range Resources (RRC) went to Buy from Hold and its price target was lifted 63% to $18. “RRC is the greatest beneficiary of higher propane prices,” Sorbara said. The vast majority of the company’s revenue comes from natural gas-related substances, according to FactSet data.
Callon Petroleum (CPE) was upgraded to Buy from Hold and saw its price target more than double from $20 to $52. The stock is trading at 4.4 times earnings. The five-year average is 12 so earnings could take shares higher.
Matador Resources (MTDR) was upgraded to Buy from Hold and saw its price target rise 68% to $42. The stock is trading at 9.8 times earnings, well below the five-year average of 33.
For investors who missed the rally a few months ago, don’t worry. More good times for oil are ahead.
Write to Jacob Sonenshine at [email protected]
