Merrill Lynch Remains Hopeful on Big Oil and Gas Valuations but Downgrades Chevron and Others
When investors see gains of close to 23% on the Dow Jones industrials and over 28% on the S&P 500, they generally assume that all or most sectors in the market performed well. It is far from a secret that it has been hard to be a steady investor in oil and gas stocks of late, and 2019 offered no reprieve from that pressure. Many investors are shunning oil and gas entirely and generally will not invest in the sector no matter how low the valuations get. Merrill Lynch had been trying to remain firm in the energy sector, but it just lowered its energy sector exposure from its model income portfolio at the start of 2020.
What is interesting here is that Merrill Lynch has talked about how cheap the energy sector has become on an absolute and a relative basis. The firm noted that its strategists and investors alike believe that energy is cheap. The report also cites a lack of confidence on multiple levels that will continue to make energy be a “show-me” story in 2020. One serious issue is the ongoing investor screens in the environmental, social and governance (ESG) theme that have grown and grown. The report even raises questions about whether energy can compete against the broader market.
Chevron Corp. (NYSE: CVX) was downgraded to Underperform from Neutral and was removed from the model Income Portfolio at Merrill Lynch after Doug Leggate and his team made the calls. Chevron’s price objective of $125 remained unchanged and compares to the $120.60 prior close. Refinitiv’s consensus analyst target price was $136.08. Chevron’s CEO recently told CNBC that he was not expecting to see sustained higher oil prices due to tensions between Iran and the United States flaring up.
That model portfolio is required to sell its position when the firm issues an Underperform rating to keep its practices unified. Leggate’s report noted that the firm has decreased its sector weighting in energy \to 9.5% from a prior 10.5%, as the firm has exited its 1% position in Chevron. In the model portfolio, the firm is allocating the proceeds to cash, but it noted that it expects “to reinvest within seven business days in a manner consistent with the portfolio’s income objective.”
Occidental Petroleum Corp. (NYSE: OXY) is Merrill Lynch’s top overall pick with compelling value, and the firm also pointed out that it has a sector-leading yield (7.3%) and that it has catalysts to close the gap just by executing on its integration plan. The firm’s $80 price objective compares with a $45.00 recent share price, and the consensus price target is just $49.32.
Exxon Mobil Corp. (NYSE: XOM) is still the top “major” pick at Merrill Lynch, and the firm still has a $100 price objective inside this big sector call. Exxon traded at $70.97 ahead of the call, and the consensus target price is barely $79.00. Exxon’s dividend yield is now just under 5% (at 4.97%). Several other firms recently have used some loose guidance data from the company to handily lower earnings expectations for the fourth quarter of 2019.
There were still some quite positive views on valuations and on other drivers for investors to consider. As the recent sector valuation report was over 100 pages and covered 20 or more companies this week, we have focused on the ones where changes were more evident.
Apache Corp. (NYSE: APA) was shown as Neutral in the big sector call for 2020, but Tuesday’s analyst notes at Merrill Lynch showed that Apache has been raised to Buy. Its prior price objective was $28, but that was raised to $36 in the new call. Apache was trading up a whopping 20% at $30.75 after announcing a significant oil find along with Total in offshore Suriname.
Atmos Energy Corp. (NYSE: ATO) was raised to Buy from Neutral with a $120 price objective, after having just been reinstated as Neutral on December 4. The firm’s prior view was that Atmos still had a sustainable runway but its top-tier growth was priced in at the level of that time ($105.47), compared with $110.50 at the current time.
EOG Resources Inc. (NYSE: EOG) was raised to Buy from Neutral. Shares closed up 4% at $88.44 and had a consensus target price of $101.51. PBF Energy Inc. (NYSE: PBF) also was upgraded to Buy from Neutral.
The report was also more constructive for the smaller exploration and production for 2020. The firm noted that its “outspend and balance sheet profiles have improved” while the price of WTI oil appears to be more firm. Leggate’s focus is on three companies with improving and sustaining free cash flow outlooks and with upcoming catalysts.
Diamondback Energy Inc. (NASDAQ: FANG) was noted as having an oil guidance that appeared to be beatable and with upside to cash flow in 2020.
WPX Energy Inc. (NYSE: WPX) was viewed strongly as the deal accretion for Felix is underappreciated, and the firm is handily above consensus on its price objective.
Parsley Energy Inc. (NYSE: PE) was viewed positively for its post-Jagged Peak merger possibilities that will grow the company.
As far as the value versus the rising risks in energy, Merrill Lynch’s report says that the value is being overlooked and that things might be too negative for the energy sector as an investment. Leggate’s report said:
We believe the pendulum has swung too far, conflating weak sentiment with the reality of some E&P business models deservedly de-rated as confirmation of a secular decline: the DCF of zero is zero and is a justifiable outcome if perpetual promises of FCF never materialize. In recent days, the geopolitical backdrop has changed, and to ignore ramifications for oil risks exacerbating stock specific value already overlooked. Our stock specific approach is unchanged; but when taken together, 2020 lines up to be a recovery year within the framework laid by our strategists where value outperforms momentum.