BofA Equity Research likes FANG and OVV - Feb 10

[dan_s]

From BofA Equity Research 2-10-2022 They believe that the upstream oil & gas sub-sector as a group is trading at a 25% discount to their valuations based on the oil price averaging $70/bbl. My valuations are based on LT oil price of $80/bbl, but I am using historically low multiples of operating cash flow to value the upstream companies. As of the Feb 4 closing prices, the Sweet 16 was still trading at just 3.24X my operating cash flow estimates for 2022. That is an insane valuation for companies the quality of the Sweet 16.

Spot may be $90 but long dated oil now sits above $70!

While all eyes are on spot prices creeping back above $90 after last month’s expiry, has
anyone noticed what’s happened at the long end of the curve? Over the past month long
dated Brent has jumped 10% & in our view has critical implications on the implied value
of US oils. In fact at the start of the year we suggested 2022 was the year the equity
market may be forced to reset expectations of long-term oil prices, which we notionally
suggest at the midpoint of a $60 - $80 trading range at the long end of the curve that
has held since Saudi’s unilateral intervention to stabilize oil markets in early 2021 and
the level we believe is necessary for Saudi Aramco to meet its obligations as a publicly
traded company. With this simple rationalization of where we see oil markets when
Saudi is not challenged for market share, we continue to see the US oils materially
undervalued, with average upside of 23%, and a current long dated oil price ‘discounted’
of ~$49 WTI.

In our view the secular reset in the sector outlook we laid out in mid-2020
is not over by some margin; but it won’t be a straight line and with that caveat we keep
one eye on some obvious near-term hazards once winter demand peak has passed.

Shoulder season may be very short lived

Elevated Euro gas prices are driving a natural pivot to heating oil that our commodity
team has estimated at 500,000 – 1mm bpd; but it’s also driving a swing by refiners to
lower sulfur crudes. But while both put an incremental bid under Brent, conflicting data
points risk undermining confidence in the duration of current spot price strength beyond
seasonal gas support that will inevitably wane. First, despite headline OPEC+ additions
of 800kbpd in Dec and Jan, 3rd party estimates put actual production adds at just 20% of
that level. With another 400k bpd suggested for Feb the gap is set to widen further as
other OPEC+ members face capacity limits (Russia) after higher profile misses by Angola
& Nigeria. The offset is Iran, seemingly moving towards sanctions relief but with
incremental supply no more than has been missed by OPEC+. Should this coincide with
refiner maintenance & weaker European gas, post winter, the risk of ‘shoulder season’
softness seems too obvious a trigger that can fulfil our technical teams view of oil in the
$70’s should paper markets follow through. With one eye on COVID restrictions easing
globally, our view of an upward reset in summer demand fueled by both gasoline, jet and
by inference a tighter distillate market all support our view that any weakness at the
front of the curve will be short lived – noting that per Kayross the modest pace of
seasonal global inventory builds stalled this week, with Cushing inventories at the WTI
benchmark setting a new seasonal low & US product supplied near record levels.

Focus ahead of remaining earnings: OXY, APA, FANG, OVV

At the sector level the dislocation between equity value & free cash is sufficiently wide
to leave our constructive view of the US oils intact, albeit with expectations that trading
dynamics will remain 2 steps forward, 1 step back. With the bulk of US E&P earnings
still ahead we continue to advocate relative focus on those names that can exploit the
biggest dislocations in value through rate of change via deleveraging the second order
effect of reduced equity volatility, and share buy backs: of those names still to report our
focus is OXY, APA, FANG and OVV. But at $70 WTI the whole sector is undervalued, in our
view.