Stock Analysis & Ideas

Goldman Sachs: These 3 Oil Stocks Are Set for Strong Gains

Russia’s war in Ukraine won’t just impact Russian soldiers and the Ukrainian people. The Western nations have imposed heavy sanctions on Russia, cutting it off from most international banking systems, restricting its access to US dollars, and preventing its physical export of valuable commodities. That last may be key. Russia is the world’s largest exporter of natural gas and second largest exporter of crude oil, and its clear to see that the world’s commodity markets, especially the hydrocarbon fuels markets, are in for a nasty shock.

Not everyone will suffer, however. If Russia’s oil companies are looking at hard times ahead, we have to remember that demand for oil will not disappear. If consumers don’t get it from Russia, they’ll buy it somewhere – and now we should remember that Texas produces some 43% of all US hydrocarbon output, and that state is one of the world’s top five oil producers, in the same league as Russia and Saudi Arabia.

With that in mind, Goldman Sachs analyst Neil Mehta, rated 5-stars at TipRanks, has picked out three oil stocks that he sees as winners going forward. These are Buy-rated stocks, with plenty of upside potential, and a closer look may help explain why Mehta finds them compelling. Let’s dive in.

Diamondback Energy (FANG)

The first Goldman Sachs pick is Diamondback Energy, a Texas-based player highly active in the richly productive Permian basin. The Permian was the center of the US oil boom in recent years, and put Texas back on the global map of oil producers. Diamondback’s production reflects the region’s productivity; the company recorded output of 387,100 barrels of oil equivalent daily in 4Q21. This was slightly higher than the full-year average of 375,300 barrels daily.

Strong production and high prices led to high revenues and earnings. Diamondback’s top line has been growing consistently since rebounding from the ‘corona bottom’ in 2Q20. In the recent Q4, Diamondback reported $2.02 billion in revenues, up an astounding 162% year-over-year. EPS came in at $3.63 per diluted share, based on just over $1 billion in net income. This was well over the $3.37 forecast, and like revenues, Diamondback’s EPS has been rising steadily for nearly two years now.

This company has a strong, and long-standing, commitment to returning half or more of its free cash flow to the shareholders, via dividends and buybacks. It has stuck to that policy, and recently declared a cash dividend of 60 cents per common share. This represents a 20% increase over the last quarter’s declaration, and the $2.40 annualized payment gives a yield of 1.9%. The company also bought back over 3.85 million shares during the period, spending $409 million to do so.

In coverage of Diamondback for Goldman Sachs, Mehta writes: “We continue to see favorable capital returns and debt reduction in 2022 given our estimates of $6 bn in FCF (25% yield) at our bullish commodity price outlook. We expect the company to allocate above its minimum 50% of FCF to shareholders (we see 13% returns assuming a 60% FCF payout) in current, above mid-cycle, commodity prices and see greater allocation going forward as the balance sheet continues to strengthen.”

To this end, Mehta rates Diamondback shares a Buy, while his $188 price target indicates potential for ~51% appreciation this year. (To watch Mehta’s track record, click here)

Out of 20 recent analyst reviews on FANG, 19 are positive, suggesting a Buy, against just one Hold. This gives the stock its Strong Buy consensus rating, and the $156.63 average price target indicates ~26% upside potential from the current trading price of $124.56. (See FANG stock analysis on TipRanks)

Ovintiv (OVV)

The next stock on Goldman Sachs’ radar is Ovintiv, one of the North American hydrocarbon industry’s large-cap players. Ovintiv, which relocated from Canada to the US just two years ago, is an $11 billion company with primary assets at Montney, on the Alberta-British Columbia line, at Anadarko, in Oklahoma, and in the Permian Basin of Texas. In addition, the company has smaller holdings in the Bakken formation of North Dakota and Uinta basin in Utah. In short, Ovintiv has its hand in most of North America’s most productive oil regions.

That portfolio of assets has led to Ovintiv’s strong revenues over the past couple of years. The company has seen six consecutive sequential gains in quarterly revenue, along with high earnings. In the last reported quarter, for 4Q21, the company realized $1.4 billion in net income, along with cash from operating activities of $3.1 billion, and free cash flow of $1.7 billion. Ovintiv made further progress in reducing its debt load, paying down some $2.3 billion. Management predicts hitting its $3 billion net debt target by the second half of this year, as long as oil prices remain above $85 per barrel. Given that oil is consistently trading above $120 right now, this is an achievable outlook.

In addition to paying down debt, Ovintiv has also boosted its dividend, increasing the payment to 20 cents per common share quarterly, or 80 cents annualized. This gives the dividend a yield of 1.7%.

Covering Ovintiv for Goldman Sachs, Mehta reminds investors that there are considerable gains in store for the stock in 2022. The analyst rates OVV a Buy, and his $71 price target implies an upside of ~65% on the one-year time horizon.

Backing his bullish stance, Mehta writes: “Shareholder returns will be in the form of share repurchases or variable dividends (we expect a focus towards share repurchases given the company is trading at a discount to peers), while the remaining FCF will be used for further debt reduction and small bolt-on acquisitions. We believe the focus for the company, aside from achieving its net debt target, will be on its ability to offset inflationary pressures through operational efficiencies, and we see potential S&P 500 inclusion (management noted it met all the criteria with positive 4Q earnings) as another catalyst for the shares to outperform.”

Overall, this stock gets a Moderate Buy rating from the analyst consensus, based on 12 reviews breaking down 8 to 4 favoring the Buys over Holds. The shares are trading at $43.12 and have an average price target of $55.54, for ~29% one-year upside. (See Ovintiv stock analysis on TipRanks)

Hess (HES)

Last but not least is Hess, a $28 billion hydrocarbon exploration and extraction company, headquartered in New York City. Hess has a truly  global reach, with operations in North Dakota’s Bakken shale, in the waters of the Gulf of Mexico, off the coasts of Guyana and Surinam, in the Libyan desert, and offshore of Thailand and Malaysia. These operations are known for strong production; in 4Q21, Hess realized 295,000 barrels of oil equivalent daily from them (excluding Libya, where the political situation remains unsettled at best). The Bakken shale let the way, with 159,000 barrels worth of that production.

These numbers crossed rising gas and oil prices to bring Hess its best revenue totals in over two years. The top line rose from $1.21 billion in 4Q20 to $2.56 billion in 4Q21, an impressive year-over-year gain of 112%. Revenues also beat an industry forecast of $2.05 billion. In earnings, Hess brought in 85 cents per share in net income, far ahead of the year-ago quarter’s 58-cent EPS loss. The 4Q21 net EPS was also head of the forecast, beating the estimate by 16%.

Looking forward, Hess expects its output to increase; the 330,000 to 340,000 barrel of oil equivalent per day estimate for 2022 represents a 12% to 15% increase from 2021’s production numbers. In a note of particular interest to investors, Hess announced in February that production at the Liza Phase 2 Development, an offshore exploration project in Guyana, South America, had begun. The company expects this project to reach 220,000 barrels of oil equivalent daily before the end of this year.

Once again, Neil Mehta has the lowdown on this stock for Goldman Sachs, and he sees plenty of catalysts ahead to keep the share price up. Mehta writes: “We believe the company is uniquely positioned to benefit from: (1) long-term oil growth from Guyana at a low supply cost and (2) our positive outlook for longer-term oil prices driving above-consensus expectations for cash flow. We expect Guyana to drive the next leg of oil growth for HES with ~0.9 mn bpd of gross oil production in 2026E (vs. 120K bpd in 4Q21)… With Liza Phase 2 production now online and the repayment of its remaining $0.5 bn term loan, we see a potential shift in the use of FCF towards capital returns, which can drive greater credit to shares.”

These comments back up Mehta’s Buy rating here, and his $147 one-year price target implies an upside of 57% for HES shares.

The Wall Street analyst consensus on this one shows that the bullish view is widely shared. There are 11 recent reviews of HES, and those include 10 Buys against a single Hold. The stock is selling for $93.08, and its $115.82 average target suggests ~24% upside potential. (See HES stock analysis on TipRanks)

To find good ideas for oil stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.

Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.

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