Companies with low-break even oil price positioned to deliver strong free cash flows.
In the last year-and-half, there has been a significant change in sentiments for crude oil. The pandemic driven oil price collapse saw Brent crude oil futures briefly trade in negative territory. With expansionary monetary policies and economic revival, West Texas Intermediate (WTI) now trades near seven-year highs. There seems to be more upside for crude oil and this factor makes energy stocks attractive.
In July 2021, Goldman Sachs forecast that Brent will be averaging above $80 in the third quarter. Bank of America had a more bullish estimate for crude oil at $100 by summer of 2022. More recently, BofA opined that a colder-than-usual winter could accelerate Brent’s rally to $100 per barrel.
In all probability, it seems that oil is likely to trade above $80 per barrel in the coming quarters, with WTI futures starting the week above that psychological threshold for the first time since November 2014, Bloomberg reported this morning. Further, with economic recovery, oil can potentially sustain at higher levels. For crude oil companies, it would imply higher operating and free cash flows. While energy stocks have already witnessed some rally, there seems to be more upside looming.
Let’s discuss four energy stocks that are poised for upside and possible dividend growth in the coming quarters.
- Chevron (NYSE:CVX)
- Lundin Energy (OTCMKTS:LNDNF)
- Exxon Mobil (NYSE:XOM)
- Equinor (NYSE:EQNR)
Energy Stocks to Buy: Chevron (CVX)
Chevron is among the top names to consider in the list of energy stocks. CVX stock is worth holding for income investors, offering a dividend yield of 5.14%. With higher crude oil price, dividend growth seems likely.
Besides the oil price tailwind, there are three primary reasons to like Chevron.
The company has a strong credit profile with a net-debt-ratio of just 21.0%. Therefore, there is ample financial flexibility to pursue aggressive exploration and production to benefit from higher oil price.
Chevron also has a quality asset base with 84MMB0e of 6P resources, i.e., reserves that are proved, probable and possible. In the last five years, the company’s reserve replacement ratio has averaged 99%. A strong reserve position provides clear cash flow visibility for the long-term.
In the upstream segment, Chevron also has low breakeven assets. The company reported operating cash flow of $7.0 billion for second quarter 2021. If crude trades near $80 per barrel, quarterly cash flows can be near $10.0 billion.
Therefore, there is ample headroom for dividend growth and aggressive share repurchase. Additionally, the company can continue to invest in core assets and build a renewable portfolio.
At a forward price-to-earnings (P/E) ratio of 15.3x, CVX stock looks attractive. The stock has been in a consolidation mode in the last six months. A break-out on the upside seems imminent.
Lundin Energy (LNDNF)
LNDNF stock is trading near 52-week highs. However, there seems to be more potential for Lundin Energy, an under-the-radar name among energy stocks.
Lundin Energy has assets with a focus on the Norwegian Continental Shelf. Currently, the company has more than one billion barrels of resources and reserves.
For 2021, Lundin Energy expects to deliver production of 180MBOepd to 195MBOepd. Production is expected to increase to 200MBOepd by 2023. Importantly, with new projects coming on-stream, production is likely to sustain over 200MBOepd in the next few years.
Lundin is also attractive because of its low breakeven assets. For Q2 2021, the company reported revenue of $1.3 billion and free cash flow of $423 million. The average realized oil price for the quarter was $68 per barrel.
Therefore, even if oil is around $75 per barrel, Lundin Energy is positioned to deliver free cash flow in excess of $2.0 billion.
LNDNF stock currently has an annualized dividend of $1.59, which implies a healthy yield of 4.38%. Considering the cash flow potential, the stock is another dividend growth name worth adding to the portfolio.
From a balance sheet perspective, Lundin reported net-debt-to-EBITDAX of 1.0 as of Q2 2021. (Oil companies typically use a financial metric of Earnings Before Interest, Taxes, Depreciation (or Depletion), Amortization, and Exploration Expense.) Additionally, the company has a total liquidity buffer of $1.8 billion.
With a strong balance sheet, an investment grade credit rating does not come as a surprise. Lundin Energy therefore has the financial flexibility to pursue aggressive exploration driven growth.
Energy Stocks to Buy: Exxon Mobil (XOM)
XOM stock is another attractive name among energy stocks as crude oil trends higher. Exxon Mobil’s upstream segment is likely to deliver strong cash flows in the coming quarters.
Even for the next few years, the upstream segment is positioned to benefit. Between 2021 and 2025 the company’s upstream investments have an average cost-of-supply of $35 per barrel. Therefore, if oil remains around $80 per barrel in the next few years, free cash flows are likely to be robust.
In terms of specific assets, Guyana and Permian assets are likely to remain cash cows. Assets in Guyana are estimated to have resources of 9Boeb. Similarly, Permian has 10Boeb of resources with 70% liquids.
Exxon Mobil estimates that both these assets can deliver a combined operating cash flow of $7.5 billion by 2025. The estimate is based on $50 per barrel Brent price, adjusted for inflation from 2021. If the positive momentum for oil sustains, operating and free cash flows can be possibly higher.
XOM stock is also attractive from a dividend perspective. Currently, the stock has a dividend yield of 5.7%. Considering the low-break even assets and the FCF potential, dividends are sustainable.
HSBC recently opined that Equinor is likely to be a winner from surging European natural gas price. At the same time, HSBC believes that “60%-80% of sales are linked to oil prices.” Therefore, with Brent trending higher, EQNR stock has also been in an uptrend.
Equinor has some quality assets in the Norwegian Continental Shelf. The region has low geo-political risk and assets have an attractive break-even.
To put things into perspective, discovered resources between 2019 and 2021 have an average breakeven of $30 per barrel.
Further, the company expects to deliver average annual FCF of $4.5 billion through 2030. This is with an assumption of $60 per barrel oil. If Brent remains firm at current levels, the FCF visibility is higher.
It’s worth noting that EQNR stock has a current annualized dividend of 72 cents per share. Considering the cash flow visibility, dividend growth seems likely. Therefore, the stock looks attractive at a forward P/E of 9.5x.
Coming back to the business, Equinor will be investing $23 billion over the next five years in the renewables segment. Higher oil prices will help in a gradual portfolio transformation for the Norwegian company. However, the upstream business will remain the cash-cow in the next decade.
This article originally appeared at InvestorPlace
On the date of publication, Faisal Humayun did not have (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 modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.