BofA raising oil price deck and stock valuations - June 24
Posted: Thu Jun 24, 2021 4:50 pm
Interesting comments from BofA Equity Research Team that recently said they seen a strong case for $100/bbl WTI early in 2022. My comments are in blue.
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In concert with our global oil team we are raising oil prices through 2023 with av. Brent prices now expected at $68 in 2021 (from $63), $75 in 2022 (from $60) and $65 in 2023 (from $60). For now our long/term oil deck of $60 Brent ($56.50 WTI) is unchanged although we believe risks of an extended up cycle remain in place. The impact on our US coverage is meaningful when viewed through the lens of our E&P valuation framework that defines value on free cash flow . There are offsets, specifically increased likelihood of Fed action already evident through increased market volatility. But the net is still higher valuations (10% on average) and an increasingly stark outlook between oil & natural gas.
Oil over gas: MRO to Neutral; RRC and CNX to U/perform
By our analysis, the impact of higher oil prices is transparent: higher free cash as a % of equity value for the next 3 years after adjusting for hedging. For some, this results in competitive valuations even if this falls against a stagnant strategic outlook that may not otherwise be enough to distinguish the investment case from peers. Nevertheless acknowledging higher free cash flow and the prospect that oil price strength is sustained beyond BofA’s current view means it makes little sense to retain underperform ratings on oil levered names particularly v us natural gas. With this backdrop, MRO is upgraded to Neutral; RRC & CNX are cut to Underperform. < MY TAKE is that BofA is under-estimating how significantly under-supplied the U.S. natural gas market could be heading into the 2021-2022 winter.
Raising Cimarex (XEC) Price Target: not because of the merger; in spite of it!
We do not view the proposed merger with Cabot as a potential positive; our upgrade presupposes the deal may not close and recognizes XEC’s lagging performance since the 5/24 announcement which contrasts with a moderate but still impactful increase in free cash implied by our updated price deck. Our Price Target moves to $90 – implying upside of 37% < My current valuation of XEC is $109.
We now see XEC competitive vs peers and with one of the highest implied free cash flow yields in the sector at 20% in 2022. With the proxy expected within weeks and our view that XEC has effectively put itself in play, we believe the relative risk/reward for XEC has improved.
Structural upside case for US oils remains in place
We continue to believe US oils are undervalued; but we also see risks to long/term oil higher by a combination of demand recovery, cautious industry investment on an evolving ESG debate & critically US E&P capital discipline that we see as a new normal. The trajectory for oil prices won’t be a straight line ; but with a confluence of issues tightening Oil Market balances we see control put back into the hands of OPEC and we see only one outcome - range bound oil markets at levels above what’s discounted in the US oils (<$50 WTI ).
Staying with top ideas: XOM, OXY, HES, FANG, DVN
For stock selection our preference remains yield, catalysts & rate of change where capital efficiency and capital structures absent liquidity risk amplify the impact of free cash flow on equity values. Top ideas are XOM, OXY, HES, FANG and DVN. But, with our commodity team suggesting Brent sees $100 in 2H22, we currently have no oil weighted name rated Underperform and a clear preference for oil over gas.
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If oil does go over $100, all of our Small-Caps should double and some have the potential for 500% upside. "Forecasting is difficult, especially when it is about the future." - Yogi Berra.
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In concert with our global oil team we are raising oil prices through 2023 with av. Brent prices now expected at $68 in 2021 (from $63), $75 in 2022 (from $60) and $65 in 2023 (from $60). For now our long/term oil deck of $60 Brent ($56.50 WTI) is unchanged although we believe risks of an extended up cycle remain in place. The impact on our US coverage is meaningful when viewed through the lens of our E&P valuation framework that defines value on free cash flow . There are offsets, specifically increased likelihood of Fed action already evident through increased market volatility. But the net is still higher valuations (10% on average) and an increasingly stark outlook between oil & natural gas.
Oil over gas: MRO to Neutral; RRC and CNX to U/perform
By our analysis, the impact of higher oil prices is transparent: higher free cash as a % of equity value for the next 3 years after adjusting for hedging. For some, this results in competitive valuations even if this falls against a stagnant strategic outlook that may not otherwise be enough to distinguish the investment case from peers. Nevertheless acknowledging higher free cash flow and the prospect that oil price strength is sustained beyond BofA’s current view means it makes little sense to retain underperform ratings on oil levered names particularly v us natural gas. With this backdrop, MRO is upgraded to Neutral; RRC & CNX are cut to Underperform. < MY TAKE is that BofA is under-estimating how significantly under-supplied the U.S. natural gas market could be heading into the 2021-2022 winter.
Raising Cimarex (XEC) Price Target: not because of the merger; in spite of it!
We do not view the proposed merger with Cabot as a potential positive; our upgrade presupposes the deal may not close and recognizes XEC’s lagging performance since the 5/24 announcement which contrasts with a moderate but still impactful increase in free cash implied by our updated price deck. Our Price Target moves to $90 – implying upside of 37% < My current valuation of XEC is $109.
We now see XEC competitive vs peers and with one of the highest implied free cash flow yields in the sector at 20% in 2022. With the proxy expected within weeks and our view that XEC has effectively put itself in play, we believe the relative risk/reward for XEC has improved.
Structural upside case for US oils remains in place
We continue to believe US oils are undervalued; but we also see risks to long/term oil higher by a combination of demand recovery, cautious industry investment on an evolving ESG debate & critically US E&P capital discipline that we see as a new normal. The trajectory for oil prices won’t be a straight line ; but with a confluence of issues tightening Oil Market balances we see control put back into the hands of OPEC and we see only one outcome - range bound oil markets at levels above what’s discounted in the US oils (<$50 WTI ).
Staying with top ideas: XOM, OXY, HES, FANG, DVN
For stock selection our preference remains yield, catalysts & rate of change where capital efficiency and capital structures absent liquidity risk amplify the impact of free cash flow on equity values. Top ideas are XOM, OXY, HES, FANG and DVN. But, with our commodity team suggesting Brent sees $100 in 2H22, we currently have no oil weighted name rated Underperform and a clear preference for oil over gas.
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If oil does go over $100, all of our Small-Caps should double and some have the potential for 500% upside. "Forecasting is difficult, especially when it is about the future." - Yogi Berra.