Merrill Lynch Makes 4 Big Oil Upgrades, Bracing for $60 Oil in 2017

August 16, 2016 by Jon C. Ogg

Can it finally be the case that there is good news in the oil patch these days? It may be true, but the qualification for what makes for good news in 2016 might be very different when compared to good news of 2014. Several things have happened of late, with Goldman Sachs calling for a stable price range and with U.S. oil rig counts growing seven weeks straight with $40 or so oil — currently closer to $45 a barrel.

Now we have Merrill Lynch changing its tune on the oil patch. The firm’s strategist is Savita Subramanian, and she has raised Merrill Lynch’s energy sector focus up to Overweight. The firm’s commodity strategists now forecast a significant rally in oil prices, and without surprise they are viewing that as bullish for energy stocks. The official view is now for $60 oil in 2017.

Subramanian pointed out that energy’s depressed earnings may stand out at a time that energy remains underowned. Her note said:

Energy looks expensive on depressed earnings, but higher oil prices should drive higher earnings estimates. Investors are still underweight the sector and the sector’s weight in the S&P 500 has fallen to historically bullish levels.

Doug Leggate, one of the Merrill Lynch energy equity analysts, has come out with several upgrades in the oil and gas stocks. There may be more upgrades coming if the firm’s view is as universal as it seems.

Marathon Oil Corp. (NYSE: MRO) was raised to Buy from Neutral. The firm’s price objective was raised to $21 from $20. Leggate’s upgrade note said he recognizes an improved risk versus reward profile along with the firm’s resource outlook. If this pans out, it implies a total return upside north of 40%. Leggate said:

Marathon Oil remains one of the most oil levered of the large cap US oils, with a production mix weighted 65% to liquids (54% oil). While this has positioned Marathon with attractive upside versus peers we have previously viewed this as a binary outcome of higher oil prices. However, over the past few months we believe a series of events have improved MRO’s relative investment case led by an improved balance sheet outlook post disposals, increased capital flexibility and critically, the recent PayRock acquisition that in our view moves Marathon into the ‘rate of change’ bucket amongst the large cap U.S. oils.

Marathon Oil was trading up almost 1% at $15.03 on Tuesday. Its consensus analyst price target is $18.00, and it has a 52-week trading range of $6.52 to $20.44.

Leggate added Devon Energy Corp. (NYSE: DVN) to the firm’s US 1 list of top ideas, noting that Devon is a binary value and it is viewed as a rate of change in an overweight energy portfolio. Leggate said that Devon checks the box on the three themes that frame Merrill Lynch’s sector view: dislocation, rate of change and binary value. Leggate also expects Devon’s guidance to move high enough to beat estimates and to guide higher in the second half of 2016.

Devon shares were last seen up almost 1% at $42.26, and the consensus price target is $45.07. Its 52-week range is $18.07 to $48.68.

Merrill Lynch’s Timna Tanners raised Noble Corporation PLC (NYSE: NE) to Neutral from Underweight. The upgrade is based on backlog security, potential refinancing and on valuation. The call also highlights debt refinancing as a potential catalyst as peers have done deals. The firm’s $7.50 price objective remains flat, but that target was based on 10 times enterprise value to EBITDA on what is expected to remain a still-challenged 2018.

Noble was trading down 2% at $6.60 on Tuesday. Its consensus analyst target is $7.83, and its 52-week range is $6.33 to $14.64. Note that this one has been hitting 52-week lows of late, so it is important to remember that weak stocks often remain weak.

Tanners also raised Patterson-UTI Energy Inc. (NASDAQ: PTEN) to Neutral from Underperform, based on the firm’s more positive sector view. The U.S. land drillers can be an early beneficiary of a recovery, yet Patterson-UTI pricing power in both segments remains challenged. The price objective was raised to $22 from $21 in the call.

While the call is for U.S. land drillers being an early beneficiary of a recovery, Patterson-UTI’s Neutral rating is due to its pricing power in both segments remaining challenged. Merrill Lynch’s increased target is after the enterprise value to EBITDA multiple for 2018 expectations was raised to 10 times from 9.5 times.

Patterson-UTI shares were last seen trading up 1.2% at $20.33. its consensus analyst target is only $21.13, and its 52-week range is $10.94 to $22.12.

Merrill Lynch raised Sasol Ltd. (NYSE: SSL) to Buy. Karen Kostanian, the analyst covering this issue, said that the worst has been priced in and she believes that Sasol is levered to the oil price. Its price objective was actually lowered overseas, but that was due to currency and higher potential capital spending. With Sasol’s valuation now below true peers, Kostanian’s report said:

We upgrade Sasol Limited to Buy as we believe that most of bad news on capex, oil price and ZAR is already priced in. We lower our price objective to ZAR430/share on the back of stronger ZAR and higher potential capex. Valuation is now below true peers. We continue to maintain that Sasol is well positioned to weather lower oil prices due to ample reserves and low oil price break-even.

Sasol’s American depositary shares trade in New York and were last seen at $28.27. Its consensus price target is $32.00, and its 52-week range is $21.07 to $34.73.

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