Just two things are keeping a lid on oil stocks: oil and stocks.
The black, viscous substance is having trouble staying above $50 a barrel less than a year after it had trouble staying below $100. As for stocks, investors remain leery of the recent rally and are willing to pay only low multiples of what are forecast to be drastically reduced earnings this year.
They may want to loosen up a bit, if Tina Vital, an oil analyst at Standard & Poor’s, has the industry figured right. She expects crude oil prices to hit bottom not far from where they are now and to double in the next few years as the global economy bounces back.
“It looks like oil prices are finding some footing,” she said. OPEC is holding the line on production, due largely to the implicit threat of Saudi Arabia, the cartel’s largest member, to be less rigorous about production cuts if other members do not display greater discipline.
Anything that helps support oil prices supports the stocks, but Vital considers shares of large integrated energy companies to be attractively priced even without significant gains in the backdrop for crude.
“This is an uncomfortable place to be in because everything is so uncertain,” she acknowledged. But that discomfort has generated a lot of selling that she contends has left energy companies trading at bargain valuations “that we haven’t seen in a few years.”
She especially likes the super-majors for their financial strength, something in short supply these days. She has “strong buy” ratings on Exxon Mobil, Chevron and ConocoPhillips.
“What an investor needs to look at in a market like we’re in are those firms that have strong balance sheets, where cash is king,” Vital advised.
Better to Be Predator Than Prey
Having a princely sum in the bank, plus access to more at a time when other businesses are shut out of the credit markets, helps the super-majors “take advantage of weaklings,” she said, by developing new production sources when rivals cannot and by pursuing acquisitions on favorable terms.
She noted that several so-called legacy projects, the immense oil and gas fields that take many years to plan and develop, are about to start paying off. The super-majors are lucky to show any increase in production in most years - the law of large numbers is still being enforced - but output from these projects should produce a “growth spurt.”
She foresees production for Exxon and Chevron rising 4 percent this year and 2 percent annually for several years after that. She predicts less near-term progress for Conoco, a more minor major, and then a run of 2 percent annual growth.
Vital is no perma-bull Pollyanna. She warns that big oil will suffer a hit to profits this year just as other industries will. She anticipates a 61 percent decline in 2009 operating earnings.
But shares of the super-majors have been trading at barely 11 times those reduced earnings, compared to nearly 14 times the earnings forecast for the broad-based S&P 500. Also, she envisions a swift rebound next year, with earnings up 51 percent. Investors should focus on the brighter future, in her view, and not dwell on the dim present.
“When things look bleak and we don’t know when they will turn around,” Vital said, “it provides a great opportunity to buy great assets for your portfolio.”
