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4 U.S. Upstream Stocks That Investors Should Consider

The Zacks Oil and Gas - Exploration and Production - United States industry has lately been pegged back by investor skepticism toward risky assets and lower realizations, to go with uncertainties related to slowing global economic growth and inflationary pressures. Although macro challenges are leading to some demand concerns and doubts, we think the space still has fuel left in the tank, especially for the operators that target growth opportunities and operating efficiency initiatives. We advise investors to focus on Cheniere Energy LNG, Magnolia Oil & Gas MGY, PDC Energy PDCE and Northern Oil and Gas NOG.

About the Industry

The Zacks Oil and Gas - US E&P industry consists of companies primarily based in the domestic market, focused on the exploration and production (E&P) of oil and natural gas. These firms find hydrocarbon reservoirs, drill oil and gas wells, and produce and sell these materials to be refined later into products such as gasoline, fuel oil, distillate, etc. The economics of oil and gas supply and demand is the fundamental driver of this industry. In particular, a producer’s cash flow is primarily determined by the realized commodity prices. In fact, all E&P companies' results are vulnerable to historically volatile prices in the energy markets. A change in realizations affects their returns and causes them to alter their production growth rates. The E&P operators are also exposed to exploration risks where drilling results are comparatively uncertain.

3 Key Investing Trends to Watch in the Oil and Gas - US E&P Industry

Sharp Drop in Natural Gas Prices: While natural gas hit $10 per MMBtu for the first time since 2008 in 2022 and gained approximately 20% last year, the fuel is facing a steep selloff lately, primarily due to unseasonally warm weather through the winter. As is the norm with natural gas, changes in temperature and weather forecasts can lead to price swings. The latest models anticipate tepid temperature-driven consumption over the near term (with less extensive use of heaters across homes and businesses), which is a negative for prices. The protracted downtime associated with the fire breakout at the Freeport LNG export plant in Texas has also been a concern.

Effects of High Inflation: Most U.S. energy companies (including the upstream operators) have been experiencing rising costs in the form of increased expenses related to maintenance and inventory. The inflationary environment, together with supply-chain tightness, is not only pushing costs higher but also affecting their capital programs. Apart from being hard to ignore, escalation in expenses is also drowning out the benefits of any commodity price increase. In our view, the inflation-associated headwinds will continue to challenge growth and margin numbers with little chance of a quick resolution. This may lead to a rough road for oil/gas equities. In particular, worries about weaker energy demand due to the threat of recession (spurred by high interest rates and slowing consumer spending) might jeopardize the commodity’s ascent.

Companies Prioritizing Returning More Cash to Shareholders: The sharp increase in crude prices last year allowed the upstream operators to deliver a solid financial performance. In particular, cash from operations is on a sustainable path, with revenues improving and companies slashing capital expenditures from the pre-pandemic levels amid higher commodity realizations. To put it simply, the environment of strong prices in 2022 helped the E&P firms to generate significant “excess cash,” which they intend to use to boost investor returns. In fact, more and more energy companies are allocating their increasing cash pile by way of dividends and buybacks to pacify the long-suffering shareholders.

Zacks Industry Rank Indicates Bearish Outlook

The Zacks Oil and Gas - US E&P industry is a 42-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #238, which places it in the bottom 5% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates challenging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are becoming pessimistic about this group’s earnings growth potential. While the industry’s earnings estimates for 2023 have gone down 31.8% in the past year, the same for 2024 have fallen 18.2%.

Despite the dim near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Outperforms S&P 500 But Lags Sector

The Zacks Oil and Gas - US E&P industry has fared better than the Zacks S&P 500 composite over the past year but has underperformed the broader Zacks Oil – Energy sector over the same period.

The industry has gone down 9.1% over this period compared with the broader sector’s increase of 2.6%. Meanwhile, the S&P 500 has lost 9.8%.

One-Year Price Performance


Industry's Current Valuation

Since oil and gas companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA), the industry is currently trading at 4.01X, significantly lower than the S&P 500’s 12.58X. It is, however, above the sector’s trailing-12-month EV/EBITDA of 2.93X.

Over the past five years, the industry has traded as high as 15.65X, as low as 2.95X, with a median of 6.02X.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio (Past Five Years)




4 Stocks to Watch For

Magnolia Oil & Gas: It is an independent upstream operator engaged in the exploration, development and production of natural gas, crude oil and natural gas liquids. Headquartered in Houston, TX, Magnolia is focused on the Eagle Ford Shale and Austin Chalk formations in South Texas. In particular, MGY’s oil-heavy Karnes County acreage — the primary focus of its operational plans — is considered one of the best shale positions in the United States.

MGY beat the Zacks Consensus Estimate for earnings in two of the last four quarters. The Zacks Rank #3 (Hold) company has a trailing four-quarter earnings surprise of roughly 3.9%, on average. Magnolia’s shares have lost 3.3% in a year. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: MGY


Northern Oil and Gas: Northern Oil and Gas’ core operations are focused on three leading basins of the United States — the Williston, Permian and the Appalachian. The upstream operator employs a unique nonoperating business model, which helps it to keep costs down and increase free cash flow. Prioritizing returns to investors, NOG pays a 34 cents per share quarterly base dividend following a 13% hike earlier this year.

Carrying a Zacks Rank of 3, the 2023 Zacks Consensus Estimate for Northern Oil and Gas indicates 31.7% earnings per share growth over 2022. NOG’s shares have gained 18.1% in a year.

Price and Consensus: NOG


PDC Energy: PDC Energy is an independent exploration and production operator with the Wattenberg Field in Colorado being its chief operating region. Following the SRC Energy deal in 2020, PDCE has emerged as the second-largest oil producer in the DJ Basin to go with its existing Delaware acreage. It has a favorable debt maturity profile with little near-term due, while a disciplined approach to capital spending, together with robust commodity prices, should boost free cash flow generation in 2023.

PDC Energy’s expected EPS growth rate for three to five years is currently 38.4%, which compares favorably with the industry's growth rate of 25.7%. The company currently carries a Zacks Rank #3. Meanwhile, PDCE has seen its shares lose 6.5% in a year.

Price and Consensus: PDCE


Cheniere Energy: Being the first company to receive regulatory approval to export LNG from its 2.6 billion cubic feet per day Sabine Pass terminal, Cheniere Energy certainly enjoys a distinct competitive advantage. The company is primed for significant revenue and earnings growth on the back of solid operations and long-term contracts.

Cheniere Energy has a projected earnings growth rate of 187.6% for the current year. The Zacks Consensus Estimate for this #3 Ranked natural gas exporter’s 2023 earnings has been revised 8.7% upward over the past 60 days. LNG shares have gained 8.9% in a year.

Price and Consensus: LNG


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Cheniere Energy, Inc. (LNG) : Free Stock Analysis Report

PDC Energy, Inc. (PDCE) : Free Stock Analysis Report

Northern Oil and Gas, Inc. (NOG) : Free Stock Analysis Report

Magnolia Oil & Gas Corp (MGY) : Free Stock Analysis Report

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