Energy

Why Investors Need to Buy Oil Stocks as Trump Threatens to Leave Iran Deal

Lee Jackson

Published: April 30, 2018 8:15 am

Last Updated: January 12, 2020 12:18 am

Numerous components go into the price of any commodity. Obviously, supply and demand is key, as too much supply or too little demand can cause the price to drop rapidly, as we saw back in 2014 when oil plunged to just over $26 a barrel. However, if you take the supply-demand issue and toss in a geopolitical event, then you have the makings of a potential for a surge in pricing.

When French President Macron made his state visit last week, he encouraged President Trump and Congress to stay in the Iranian nuclear deal that was forged by President Obama and then-Secretary of State John Kerry. The deal, which included pallets of money delivered to Iran, may be on life support, and the president has pushed for a much stronger agreement. With the deal unlikely to make it past the summer in many experts’ minds, it may make sense to grab more energy stocks now, as Iran oil exports could drop meaningfully with renewed sanctions and demand is increasing, especially from China.

We screened the Merrill Lynch research energy universe database looking for the companies that offer the best risk-reward, are rated Buy and have the biggest upside to the Merrill Lynch price target. We found four that look like solid plays for investors now.

Chevron

This integrated giant is a safer way for investors looking to stay or get long the energy sector, and it has a big Permian Basin exposure. Chevron Corp. (NYSE: CVX) is a U.S.-based integrated oil and gas company with worldwide operations in exploration and production, refining and marketing, transportation and petrochemicals.

The company sports a sizable dividend and has a solid place in the sector when it comes to natural gas and liquefied natural gas (LNG). Some on Wall Street estimate that the company will have a compound annual growth rate of over 5% for the next five years.

With Permian production and asset disposals targets reset, the company can raise the dividend 20% and buyback 15% of shares. Many analysts view the strategy update as appropriately conservative for one of the more oil-levered majors. The Chevron strategy through 2020 is focused on discipline enabled by step change in capital efficiency driven by doubling Permian production.

Chevron reported per-share earnings that beat the consensus forecast by Thomson Reuters. Chevron shares are up nearly 18% over the past year, recovering from a drop earlier in 2018 after the company’s fourth-quarter earnings badly missed expectations. In the first quarter, Chevron’s profits from its upstream business, which produces oil and gas, doubled from a year ago. That offset a 21% drop in earnings in its downstream segment, which includes refining crude oil into fuels like gasoline.

Chevron shareholders receive an outstanding 3.54% dividend. The Merrill Lynch price target for the shares is $138, and the Wall Street consensus target is $137.12. The shares closed trading on Friday at $126.62.

Diamondback Energy

This is a top Permian Basin play for more aggressive accounts and is a top pick across Wall Street. Diamondback Energy Inc. (NASDAQ: FANG) is an independent oil and natural gas company headquartered in Midland, Texas, and focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas.

Diamondback’s activities are primarily focused on the horizontal exploitation of multiple intervals within the Wolfcamp, Spraberry, Clearfork and Cline formations.

Wall Street analysts have noted in the past the company’s top-tier asset base, solid accretive additions and financial discipline, which they think allows for not only continued solid cash flow, but could put the company in play as a takeover target. Diamondback continues to drill some of the most economical wells in the United States as efficiencies improve, costs decrease and activity remains in the better regions.

Merrill Lynch was very positive when the company initiated a dividend, and the firm said this last month:

Underscoring increased confidence in its ability to grow cash flow, the company initiated a $0.50 annual cash dividend starting in the first quarter of 2018 Full year production guidance is ahead of expectations with emphasis on disciplined growth; efficiency gains to continue. We reiterate our Buy rating on top tier growth profile, superior cash margins, steady execution & strong balance sheet.

Merrill Lynch has a $153 price target, and the consensus target is $156.67. Shares closed Friday at $125.85.

Exxon

This remains a top Wall Street energy pick, and it is the preferred pick and also on the US 1 list at Merrill Lynch. Exxon Mobil Corp. (NYSE: XOM) is the world’s largest international integrated oil and gas company. It explores for and produces crude oil and natural gas in the United States, Canada, South America, Europe, Africa and elsewhere.

The company also manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and specialty products, and it transports and sells crude oil, natural gas and petroleum products.

Last Friday, Exxon announced estimated first-quarter 2018 earnings of $4.7 billion, or $1.09 per share assuming dilution, compared with $4.0 billion a year earlier. Cash flow from operations and asset sales was $10 billion, including proceeds associated with asset sales of $1.4 billion.

During the quarter, the corporation distributed $3.3 billion in dividends to shareholders. Capital and exploration expenditures were $4.9 billion, up 17% from the prior year.

In addition, last week the company raised the dividend by $.05 per share to $0.82, which translates to a nifty 4.22% dividend.

The $100 Merrill Lynch price objective is well above the consensus estimate of $85.98. The stock closed Friday at $77.79.

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Pioneer Natural Resources

Many Wall Street analysts love this stock for a pure crude oil play. (NYSE: PXD) operates a modern fleet of more than 24 top performing drilling rigs throughout onshore oil and gas producing regions of the United States and Colombia. Pioneer production services are supported by 100 well-servicing rigs, more than 100 cased-hole, open-hole and offshore wireline units, and a range of advanced coiled tubing units.

Pioneer is a huge player in the Permian Basin and the Eagle Ford in Texas, and the company owns more than 20,000 locations in the world’s second-largest oil reservoir in the Midland Basin. With a stellar balance sheet, the company is poised to remain a top player in the Permian as it expects to deliver solid production growth in 2018 and beyond.

The company’s unmatched depth of low-cost inventory and balance sheet allow it to compete favorably in both mild and moderate recovery case scenarios. In addition to asset and financial strength, many analysts feel that Pioneer offers the second highest multiple contraction among the large-cap Permian pure-play peers, as well as the highest free-cash-flow yield.

Investors receive just a 0.05% dividend. The Merrill Lynch price target is $230. The consensus target is $224.25, and shares closed most recently at $199.29.

There is always the outside chance that Iran decides to play ball, but given its actions over the years, it would seem unlikely, especially considering its recent bellicose statements. One thing’s for sure; oil is firmly above the $60 level and looks poised to stay there.