Goldman Sachs analyst Neil Mehta in a recent note takes a closer look at energy companies and finds that declining consumer and investor sentiment, coupled with concerns about economic growth around the world, have bolstered short-term risk factors. At the same time, Mehta believes that the longer-term view of energy stocks is positive.
“We maintain a constructive/bullish long-term position given strong cash flow, discounted valuation, growing strategic value in US gas/oil, and improving returns on and capital. We believe the focus this quarter will be on (1) production execution; (2) ability to manage costs despite higher inflation; (3) prospects for capital return; and (4) manage commodity risk through hedging,” Mehta said.
Against this backdrop, it’s no wonder Mehta sees current conditions as an opportunity to buy long-term energy stocks. The analyst is particularly bullish on two names, and he’s not the only one. According to the TipRanks platform, both tickers carry a Strong Buy consensus rating from the analyst community. Let’s take a closer look.
First, Ovintiv, is a hydrocarbon exploration and production company operating in the Unita Basin in Utah, the Bakken fields in North Dakota and the Permian Basin in Texas. The company also holds energy concessions in the Anadarko region of Oklahoma and in the Montney formation in the Canadian Rockies. Ovintiv has a market cap of nearly $13 billion and its stock has outperformed broader markets so far this year; where the S&P is down 13%, OVV shares are up 53%.
This solid performance is driven by production. Ovintiv extracts some 500,000 barrels equivalent per day. In the first quarter, this production generated non-GAAP cash flow of $1.04 billion, of which some $592 million was listed as free cash flow (FCF). The latter is important for investors, as it supports the payment of company dividends. Ovintiv’s latest dividend payment was 25 cents per common share and returned 2.1%. Ovintiv expects to double its cash return to shareholders.
To fund the planned doubling, the company will sell some of its Unita and Bakken assets for total proceeds of $250 million, and use the windfall to move its planned cash yield boost to October 1 this year. At that time, the company will begin returning 50% of free cash flow to investors. In the third quarter, most of this return is expected to come in the form of share buybacks.
In his comments on OVV, Mehta takes note of capital returns and goes on to say, “We now see a 1-year forward capital return of around 15%. We believe that the company’s improving balance sheet, differentiated return of capital to shareholders and largely reduced production/capex guidance following Q1 earnings revisions provide potential for shares to be repriced higher. .
For investors, the analyst sees several points of interest, and lays them out clearly: “(1) updates to short- and long-term net debt targets; (2) FCF generation and the firm’s ability to maintain its return on capital framework; (3) the ability to meet its production forecast due to higher Canadian royalty payments; and (4) future hedging strategy as the balance sheet improves.
In Mehta’s view, this all corresponds to a Buy rating and price target of $63, implying a 23% year-on-year upside. (To see Mehta’s track record, Click here)
Sometimes a company’s advantages are so clear that Wall Street can’t help but agree — and that’s the case here. Across 11 recent analyst reviews, all are Buy, earning the consensus Strong Buy rating. Shares of OVV are trading at $51.09 and the average price target of $68.55 indicates upside potential of 34% over the coming year. (See Ovintiv stock forecast on TipRanks)
Diamondback Energy (FANG)
For the second stock on Goldman Sachs’ list, we’ll look at Diamondback Energy, an Ovintiv peer with a market capitalization of around $22 billion and extensive operations in the Permian Basin of Texas. Diamondback generated 375,000 barrels of oil equivalent per day last year, and in the first quarter of this year that number rose to 381,400 barrels.
Diamondback has seen its earnings rise steadily since the start of 2020 and has posted six consecutive quarters of EPS gains. In 1Q22, the most recent report, the company reported diluted EPS of $5.20, based on adjusted net income of $929 million and up 126% from the prior year quarter . Total revenue for the quarter was $2.4 billion, a year-over-year gain of 103%.
Strong revenue and profit gains were complemented by free cash flow of $974 million, nearly triple the value in 1Q21. Diamondback returned 57% of that FCF to investors during the quarter, or a total of $555 million, through a combination of dividends and share buybacks. The company’s current dividend payout includes a base common stock payout of 70 cents and a variable payout of $2.35; the basis alone gives a yield of 2.3%, with the variable dividend added, this yield reaches 4.3%.
Going forward, Diamondback announced on June 21 that it would increase the base dividend to 75 cents and that it would be company policy to increase the capital return commitment from 50% to 75% of cash flow. available cash. These changes will come into effect in the third quarter of this year.
For analyst Mehta, these changes in cash yield are the first of several important points for investors to consider when looking at FANG. Listing these points, Mehta writes, “The focus of the quarter for investors will likely revolve around (1) future prospects/forms of capital return after increasing its commitment to return at least 75% of FCF to shareholders against 50% previously; (2) ability to offset inflationary pressures and meet production targets during the quarter; and (3) M&A prospects following its add-on transaction in the Delaware Basin and following the announcement of its intention to acquire the remaining stake in RTLR.
Everything FANG has going for him has made Mehta rate the stock as a buy. Its price target of $160 implies a 25% upside from current levels. (To see Mehta’s track record, Click here)
As for the rest of the street, almost all analysts agree with Mehta. 16 Buys and 1 Hold means a Strong Buy Consensus Odds. The shares are trading at $128.02 and their average price target of $180.18 implies a 12-month gain of around 41% for the stock. (See FANG stock forecast on TipRanks)
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