As 2013 rolls to a close, energy will end up being one of the underperforming S&P 500 sectors in what largely has been a tremendous year for investors. While some stocks disappointed, the energy team at Merrill Lynch are actually reasonably positive about the sector for 2014. They do not see a total collapse in West Texas Intermediate (WTI) crude due to oversupply, and they anticipate fairly firm pricing for natural gas. Their average price forecast for WTI is $92. For natural gas, they expect $3.90 per MMBtu.
In a new research report, Merrill Lynch analysts have a list of some specific energy sector themes they expect to play out over the course of the coming year. We picked the themes that may have the largest effect on investors.
Theme 1: Rising self-sufficiency in the Northeast gas market could have big implications for the entire market. With the price of gas likely to remain in a narrow range next year, Merrill Lynch suggests investors buy high-quality, large resource-based stocks. The analysts have two top names to buy.
Cabot Oil & Gas Corp. (NYSE: COG) is a name that fits the bill at Merrill Lynch. The company’s mid-December operating update reaffirmed several issues the analysts believe position the shares for another strong year in 2014. Strong production and a long-term selling agreement with Pacific Coast Summit Energy were cited as big positives. The Merrill Lynch price target for the stock is $47. The Thomson/First Call estimate is $45. Cabot closed Monday at $38.57.
Range Resources Corp. (NYSE: RRC) is the other name that the Merrill Lynch team favors. Strong production gains in its Marcellus wells are adding to overall gains that could drive revenues higher in 2014. Investors are paid a very small 0.2% dividend. Merrill Lynch has a $100 price target, but the consensus is much lower at $90. Shares closed Monday at $83.08.
Theme 2: The net asset value race has come to a halt. The coming year is about execution. The top Bakken and Permian Basin exploration and production (E&P) names outperformed by a large margin. The Merrill Lynch analysts see that outperformance may be at an end and want to focus on only the best of names.
Pioneer Natural Resources Co. (NYSE: PXD) is a huge player in the Permian basin in Texas, and it has been a huge winner for shareholders this year. Rumors have swirled the last half of this year that one of the big integrateds may target Pioneer as a takeover candidate. It would be a very expensive deal, as the company’s market cap is almost 25 billion. The Merrill Lynch price target for the stock is a gigantic $275. The consensus number is lower at $233.75, and shares closed Monday at $185.19.
Whiting Petroleum Corp. (NYSE: WLL) is ranked as the third largest producer in the Bakken shale region. Over 2013, Whiting sold off significant amounts of its assets that are not in the Bakken, including its Postle Field enhanced oil recovery assets for $817 million and its acreage in the Delaware Basin for $150 million. The company in turn is using the cash from the sales and deploying more assets into the higher-return Bakken. The Merrill Lynch price target for the stock is $79, and the consensus figure is at $77.50. Shares closed at $60.73 on Monday.
Theme 3: Following a wave of activism, “structural change” remains important in 2014. Activist investors played a vital role in reshaping some of the top names in the industry. Now that much of the change has been or soon will be implemented, Merrill Lynch looks for further performance gains in 2014.
Hess Corp. (NYSE: HES) tops the list for E&P names. The company is the second largest producer in the Bakken region. However, unlike many other operators in the region, Hess’s assets there make up less than a quarter of the company’s production and reserves. Investors are paid a 1.2% dividend. The Merrill Lynch price target for the stock is $115 and is the highest on Wall Street. The consensus estimate is set at $90. Hess closed Monday at $80.22.
Occidental Petroleum Corp. (NYSE: OXY) is another top domestic E&P name on the Merrill Lynch list for 2014. The company may be looking to sell a stake in its Middle East and North Africa operations. With an estimated value of $22 billion, the assets are located in the United Arab Emirates, Qatar, Oman, Bahrain, Yemen, Libya and Iraq. Some analysts believe that selling an $8 billion to $10 billion stake would raise needed cash for debt reduction and share repurchases. Shareholders are paid a 2.6% dividend. The Merrill Lynch price target for the stock is $130, and the consensus is at $109. Shares closed Monday at $93.23.
Theme 4: Exxon Mobil Corp. (NYSE: XOM) outperforms Chevron after years of lagging its biggest rival. Cash margins and a rising oil price have helped Chevron handily outperform Exxon. In addition, some corporate self-inflicted weakness should dissipate in 2014. Investors who have significant gains in Chevron may want to take those and buy Exxon for 2014. Investors in Exxon are paid a solid 2.6% dividend. The Merrill Lynch price target is $110, and the consensus is at $99. Exxon closed Monday at $98.51.
Theme 5: Favorable outlooks for E&P budgets could really lift oilfield services stocks focused on North America. Given the continued strength in shale development, the Merrill Lynch team favors the large cap service companies with the biggest capabilities and technology.
Halliburton Co. (NYSE: HAL) is a top oil field services name for 2014. The company is a top provider of products and services that are used in the energy industry for exploration, development and production of oil and natural gas. It serves major oil and natural gas companies throughout the world, operating in 80 countries. Investors are paid a 1.1% dividend. Merrill Lynch has a price target of $69, and the consensus is at $64.50. Halliburton ended Monday at $50.30.
Schlumberger Ltd. (NYSE: SLB) is the other top services name to own for 2014. The company looks to grow its share of E&P spending in 2014 and expects its margins to run higher than in the past. The Merrill Lynch analysts are negative on small and mid cap North American focused service companies. Investors are paid a 1.4% dividend. The Merrill Lynch price objective for the stock is $111, and the consensus target is set at $110. Shares closed Monday at $87.32.
Theme 6: The crude refining advantage moves to the South and to the West. The Merrill Lynch team sees crude production rising to the highest level since 1989. They also pinpoint two refiners that will benefit the most in 2014 that are crude-advantaged and have stock-specific catalyst for next year.
Tesoro Corp. (NYSE: TSO) is one of the names to buy at Merrill Lynch. The company operates in two segments. The Refining segment refines crude oil and other feed stocks into transportation fuels, such as gasoline, gasoline blend stocks, jet fuel and diesel fuel, as well as other products, including heavy fuel oils, liquefied petroleum gas, petroleum coke and asphalt. The Retail segment sells gasoline, diesel fuel and convenience store items through company-operated retail stations and third-party branded dealers and distributors in the western United States. It operated approximately 2,200 retail stations, including approximately 595 company-operated stations under the Tesoro, Shell, ARCO and USA Gasoline brands. Investors receive a 1.8% dividend. Merrill Lynch has a $76 target, and the consensus is posted lower at $66. Tesoro closed Monday at $58.31.
Valero Energy Corp. (NYSE: VLO), the nation’s largest independent refiner, is the other top refining name to buy. The company benefited from two well-timed spin-offs in 2013. First, in May, the company separated CST Brands, its $13.1 billion gas-and-groceries retail unit, into a standalone company. Then in December, it launched an initial public offering for Valero Energy Partners, a master limited partnership with $600 million in pipeline and oil-storage assets. Shareholders are paid a 1.9% dividend. Merrill Lynch has a $59 price target. The consensus is posted at $46. But shares closed at $48.36 on Monday.
The underperformance of the energy sector in 2013 is one of the reasons that investors may benefit by overweighting it in 2014. After such a tremendous year in the equity markets, many portfolio managers may look to move some of their high-gain momentum names to stocks that have had less of a run. Some of the top energy names to buy may be just the stocks they move to.