Oil price has been surging in the recent past and this has translated into a meaningful rally in oil and gas stocks. There are several catalysts for oil price upside and it seems likely that the positive trend is likely to sustain.
First and foremost, inflation is manifesting itself in the form of higher industrial commodity and energy price. Even with multiple rate hikes, real interest rates are likely to remain negative. This is positive for hard assets like all. Furthermore, geo-political tensions have been escalating. In general, this is positive for oil price.
Another factor is global GDP growth. In all probability, the pandemic is likely to shift to an endemic in 2022. This will help in boosting GDP growth and demand for oil is likely to increase on a relative basis.
Earlier this year, Goldman Sachs opined that oil will touch $100 later in 2022. However, it seems that the target will be achieved earlier than expected. Upside in all price also implies that EBITDA margin and cash flows will swell for oil and gas companies.
Some of the high-quality oil and gas stocks have already trended higher in the last few quarters. If oil remains firm around current levels, there is visibility for further upside for oil and gas stocks.
In this column, my focus is on three oil and gas exploration companies that have quality assets and a low break-even oil price. Additionally, I have discussed one offshore rig stock that seems poised for a comeback as the industry recovers.
Oil and Gas Stocks to Buy: Chevron (CVX)
CVX stock is among the top oil and gas stocks to consider as Brent trends higher. The stock has already returned 35% in the last six-months. However, more upside seems likely considering the cash flow visibility. In addition to the upside potential, CVX stock also offers investors a healthy forward dividend yield of 4.21%.
It’s worth noting that even during the year when oil crashed due to the pandemic, Chevron reported positive operating cash flows. The company’s assets have an attractive break-even and that’s a key reason to consider the stock.
For 2021, Chevron reported $29.2 billion in operating cash flows. Considering the trend in Brent oil price, it seems likely that OCF will be higher in 2022. Another reason to like Chevron is the company’s balance sheet. As of December 2021, Chevron reported net-debt ratio of 15.6%.
Strong financial flexibility allows the company to pursue aggressive organic and acquisition driven growth. At the same time, the company has been utilizing robust cash flows to invest in renewable assets. Chevron is likely to be more diversified in the next five-years in terms of share of renewable and non-renewable energy.
Overall, CVX stock is worth considering on dips and it’s a quality stock to consider for the long-term portfolio.
EQNR stock has also been among the top performing oil and gas stocks. In the last six-months, the stock has trended higher by 42%. The stock also offers investors an attractive dividend yield of 2.17%.
Similar to Chevron, a key reason to be bullish on Equinor is the quality of assets. To put things into perspective, the company’s break-even of discovered resources between 2019 and 2021 is $30 per barrel. As these resources deliver production upside, Equinor is positioned for healthy free cash flows in the next few years.
For year-to-date 2021 (third-quarter 2021), Equinor reported operating cash flow of $23 billion. This implies an annualized OCF potential in excess of $30 billion. It’s also worth noting that the company’s balance sheet is investment grade. As of Q3 2021, Equinor reported net-debt ratio of 13.2%.
Considering the cash flows and balance sheet healthy, Equinor has ample financial flexibility for dividends growth and share repurchase. The company has also been investing in renewable energy portfolio with a focus on wind energy. For Q3 2021, Equinor reported renewables production of 304GWh.
Overall, Equinor is another cash flow machine. Low break-even assets imply that free cash flow will remain robust even if there is some correction in Brent. For now, the outlook for 2022 is bright as Brent is possibly moving towards $100 per barrel.
Oil and Gas Stocks to Buy: Marathon Oil (MRO)
MRO stock has already seen a big rally from oversold levels. In the last six-months, the stock has trended higher by 76%. I would wait for dips to accumulate the stock, which also has dividend growth visibility.
In terms of financial momentum, Marathon expects free cash flow in excess of $2 billion for 2021. With a corporate free cash flow break-even at $35 per barrel WTI, the company is positioned for strong FCF in 2022.
Deleveraging is another reason to be positive on Marathon. For 2021, the company has pursued gross debt reduction of $1.4 billion. This is likely to help in interest cost reduction of $50 million on an annualized basis. With net-debt-to-adjusted-EBITDA of lower than 1.5, the balance sheet has improved significantly.
It’s also worth noting that as of Q3 2021, Marathon reported $184million in cash. Additionally, the company has $3.1 billion in undrawn credit facility. With a total liquidity buffer of $3.6 billion, the company is positioned for aggressive investments.
At the same time, Marathon has also approved a share repurchase target of $2.5 billion. These factors, coupled with healthy dividend growth visibility, makes MRO stock attractive.
Among the smaller oil and gas stocks in terms of market capitalization, RIG stock looks interesting. The company is a provider of offshore drilling services for oil and gas companies globally.
With Brent trending higher, companies will increase the capital expenditure. Further, offshore exploration is also likely to accelerate as it has a relatively higher break-even. This will benefit Transocean, which has a high-quality fleet of deep-water and ultra-deep-water rigs. As of December 2021, the company had a fleet of 39 rigs.
A reason to like Transocean is the company’s order backlog of $7.1 billion. The backlog provides clear revenue and cash flow visibility. It’s also likely that the backlog will swell further if Brent sustains at higher levels. At the same time, the new contracts will command a higher day-rate. This would translate into EBITDA margin expansion in the coming quarters.
From a financial perspective, Transocean reported a total liquidity buffer of $2.7 billion. With an extended debt maturity profile, there is no near-term debt refinancing pressure. Also, as EBITDA margin improves in the foreseeable future, Transocean will be positioned to deleverage.
RIG stock still has a penny stock status. However, I believe that if positive industry tailwinds sustain, the stock is poised to double in the next few quarters.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.