The oil markets are back — at least for the time being. Since breaching the psychologically critical level of $30 in late January of this year, the benchmark Brent Crude Oil Index has gained nearly 70%.
Click to Enlarge
Without the massive financial resources of Big Oil companies, mid-tier energy stocks have borne the brunt of the crude oil collapse. Now, the tables have turned as the oil markets reverse course.
There are signs that the bears have overplayed their cards when it comes to energy stocks. BP plc (ADR) (BP) kicked off with an earnings surprise last week, posting a profit of $532 million in the first quarter of fiscal year 2016. BP completely upended forecasts calling for a loss of nearly $245 million. Aided by a much improved refining business, as well as a reduced cost structure, BP could actually end up being one of many energy stocks to surprise this week.
One of the most obvious, but significant factors is technical strength in crude oil markets. Over the past 30 years, the average price of crude is approximately $42.65. But when adjusted for inflation, that average price totals $52.35. Over the past 20 years, the inflation-adjusted value for crude oil is $62.54. The bottom line here is that despite the aforementioned 70% bump in oil markets since January, black gold is still undervalued against key historical metrics.
But how long can oil rally? Positive fundamentals, such as slowing U.S. oil production and continued global efforts to suppress output, will likely drive demand higher in the near term. In addition, enthusiasm tends to beget more enthusiasm. Ultimately, macroeconomic conditions and consumer confidence will determine whether this is a sustainable rally or a one-trick pony. Unfortunately, forecasting large-scale changes is a tricky business.
For the immediate future, energy stocks have the wind at their back. With both technical and fundamental factors currently in alignment, there’s little point in trying to stop this freight train. Mid-tier firms in particular offer an enticing trading opportunity, and could turn out to be one of the more profitable ventures this year.
Here are four energy stocks that still have plenty of pop left in them.
Energy Stocks in Focus: EP Energy Corp (EPE)
Click to Enlarge
So far this year, EPE stock was downgraded by eight covering analysts, with JPMorgan Chase, followed by Vetr, issuing the latest bearish outlooks. That’s pretty bad, even for beleaguered energy stocks. So should investors see the writing on the wall and jump ship?
An indefinite buy-and-hold EPE stock is not. EP Energy does, however, have value as a nearer-term bullish trade, albeit speculative. The main driver for EPE recently has been the short squeeze. With the short percentage of float averaging 21% this year, the sustained rally in the underlying oil markets sent bearish traders ducking for cover. While a good chunk of this contrarian trade for EPE has already played out, I argue that Brent crude oil is still undervalued. Therefore, it would be fairly risk for the bears to reinitiate their short positions right now.
Additionally, EPE sold off key shale assets, taking home $420 million. That will go a long way in cleaning up its balance sheet, which is saddled with debt. Wall Street certainly appreciates the effort by management, rewarding EPE shareholders with a 19% gain over the past month. Make no mistake — it’s not enough to make EP Energy a comfortable, long-term investment.
But as an immediate play on momentum, EPE still has room to run.
Energy Stocks in Focus: California Resources Corp (CRC)
Click to Enlarge
CRC employees around 4,000 people, each working toward the common goal of providing “affordable energy for California by Californians,” according to its company website. In that regard, it’s probably one of the few energy stocks without a “bad boy” reputation.
However, don’t mistake its altruistic goals with underperformance in the markets. In March, CRC stock gained 23% overall despite heavy volatility in the second half of the month. In April, CRC shot up an astonishing 113%! As with EPE stock, CRC is weighed down with heavy short interest. In fact, at 13%, this is very close to record levels. But with key oil benchmarks continuing to do well, bearish traders must cover their positions or run the risk of a margin call.
That said, CRC is highly dependent upon fluctuations in the oil markets. When industry experts expressed concerns that major oil producers will fail to coordinate supply reductions last month, CRC took some worrying blows. True, CRC recovered rapidly. Yet, as a glorified penny stock, the message was clear — wherever oil goes, so too does CRC.
For now, oil is a hot commodity and, therefore, CRC is a hot stock. Just don’t go too crazy on this trade.
Energy Stocks in Focus: Jones Energy Inc (JONE)
Click to Enlarge
Potential buyers would be forgiven for any sideways glances ala Mary Pat Christie. But aside from the historical underperformance, JONE stock does provide a compelling nearer-term argument.
Let’s get the easy stuff out of the way. JONE stock is a huge beneficiary of the Brent crude oil rally. Equity value for the independent oil producer is up nearly 300% since late-February. Year-to-date, that puts JONE at 20%. Short interest is highly elevated relative to bearish sentiment over the past several months. That means there’s still a technical catalyst for JONE stock to move substantially forward should the broader oil markets continue their positive trek for the year.
But unlike other mid-tier energy stocks, there’s fundamental meat for JONE shareholders to chow down on. Specifically, earnings estimates for Jones Energy’s upcoming first-quarter FY2016 report have been upped significantly, from a loss of 8 cents down to just a penny in the red. Analysts are also positively revising their expectations for the full year. In theory, this would indicate that JONE is both a momentum trade and an undervalued investment.
The momentum is certainly there, although I would take the estimate revision with a grain of salt. For now, JONE stock is great for what it is — a means to capture quick profits while the market is still hot.
Energy Stocks in Focus: Eclipse Resources Corp (ECR)
Click to Enlarge
That neatly summarizes the type of year ECR has enjoyed since hitting rock bottom in late-February. Since then, ECR is up around 270%. Better yet, the oil company shows no sign of slowing down, moving up 69% in April. But can ECR keep up this incredible pace?
As a marathon runner, there’s little chance that Eclipse will survive long enough to cross the finish line. The profitability margins are absolutely horrible, even for the deflated standards of energy stocks. The massive increase in top-line sales does little to address this problem. The debt level on its balance sheet is problematic. ECR also is a free cash flow nightmare.
But as a short-term, speculative trade, ECR stock fits the bill quite nicely. As with the other mentioned energy stocks, ECR stands to benefit from the bullishness in oil markets combined with short positions that need to be covered. In addition, ECR is the subject of both quarterly and full-year positive estimate revisions. This indicates favorable sentiment shifting toward energy stocks, and this could potentially turn out to be a longer-than-expected development.
At the same time, a safer approach is to view ECR realistically — a red-hot stock that still has a few gallons left in the tank.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
