Analysts are more bullish about energy companies than are investors. (Photo by Justin Sullivan/Getty Images)
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Energy stocks make up just 4% of the S&P 500 but are expected to account for 12% of the index’s earnings in the second quarter.
That gap is one reason some analysts are bullish about the sector heading into second-quarter earnings season.
After a strong start to the year, energy names have fallen 25% from their early-June highs, underperforming the broader market. Oil and gas stocks are even underperforming the commodities themselves this year, signaling that investors have little appetite to buy in.
The stocks rose after Russia’s invasion of Ukraine in February, but those increases have since stagnated. Some analysts think the next catalyst to send the stocks higher is earnings season, which starts for most energy names next week. Refiners will be reporting earnings next week, and Chevron (ticker CVX
) and Exxon Mobil (XOM) are set to report on Friday. Many independent producers are expected to report in early August.
Analysts have mostly stayed bullish on energy throughout the recent selloff, but it isn’t clear when investors will come around to their line of thinking. In general, investors have shied away from energy, even after the stocks outperformed every other part of the market in 2021 and the first half of 2022.
Second-quarter earnings could give the companies a chance to show off their best attributes. For one thing, several companies are likely to boost their dividends, which tends to capture investor attention.
“Amid continued volatility, we see second-quarter earnings as a positive catalyst for the sector and expect another quarter of record free cash flow to support a further acceleration of cash returns,” wrote Morgan Stanley analyst Devin McDermott.
Major diversified oil companies are trading at a 55% discount to the market, and producers are trading at a 65% discount, according to McDermott.
“This is wider than nearly any time in the past decade,” he wrote. His top picks include Exxon Mobil; Canadian producers Suncor (SU) and Cenovus (CVE); oil producers Hess (HES), Diamondback Energy (FANG), APA (APA), and Ovintiv (OVV); and gas producer EQT (EQT).
Others are also bullish, though see challenges ahead that could scare some investors away.
Truist analyst Neal Dingmann expects inflation to hurt oil companies in the second half of the year, as oil service companies raise prices, and materials run short. Inflation and supply constraints are the “topic du jour” among energy investors, Dingmann wrote. He thinks those are transitory issues, however, that don’t take away from a bullish multiyear cycle for the industry. His favorite names include ConocoPhillips (COP), Antero Resources (AR), APA, Northern Oil & Gas (NOG) and Ranger Oil (ROCC).
Similarly, Bank of America analyst Doug Leggate thinks there are “grounds to be defensively positioned within the U.S. oils”, but sees several stocks worth buying too. To invest in oil, it’s worth finding names that look defensive, he writes, highlighting EOG (EOG), ConocoPhillips, and Canadian Natural Resources (CNQ).
There is also opportunity in companies that explore for natural gas. Among those, he likes Southwestern ( SWN
) and Ovintiv. Leggate also thinks U.S. refiners are worth buying, given that they pay less for natural gas — a key input cost — than some of their overseas counterparts. His favorites are Valero (VLO), Marathon Petroleum (MPC), and PBF Energy (PBF).
Write to Avi Salzman at [email protected]
