3 Beaten-Down Oil Stocks to Think About Scooping Up Before 2018
Oil prices have bobbed and weaved this year, which quickly turned the initial optimism that things would be better back into pessimism. Because of that, many investors bailed on oil stocks when crude turned lower earlier this summer in fear it would keep falling and take their investment with it. Because of that, the stock prices of several large shale drillers have lost value this year even though crude has come all the way back and then some. Three that stand out are Devon Energy (NYSE: DVN), Pioneer Natural Resources (NYSE: PXD), and Marathon Oil (NYSE: MRO), which are all down double-digits despite delivering excellent results this year.
Because of that, this year's sell-off appears to be a compelling buying opportunity since 2018 looks like it should be a much better year for the oil market. Not only has OPEC pledged to continue supporting oil prices, but demand remains healthy, and many oil producers in the U.S. are opting to return cash to investors instead of pouring everything into drilling more wells. That forecast suggests that this trio of beaten-down, top-tier shale drillers could enjoy a big bounce back in 2018.
Drilling for returns
Devon Energy's stock has fallen about 12% this year despite the fact that oil prices in the U.S. are up roughly 8%, and the company has significantly outperformed its 2017 plan. Initially, Devon thought that by year-end, it would be producing 13% to 17% more oil in the U.S. than it was producing when it exited 2016. However, thanks to excellent well performance, the company now expects to end the year producing 20% more than it did at the end of last year.
That sets Devon up for further success in 2018. The company noted that its 2018 drilling program "will represent a major inflection point for the company due to a step-change improvement in capital efficiency," meaning the company expects to get much more production out of its capital dollars going forward mainly due to its focus on drilling in its two highest-return shale plays. While that program will push output meaningfully higher, it will also fuel significant cash flow growth due to the exceptionally high returns the company can earn by drilling those wells at current oil prices. That high-return growth should provide plenty of fuel for Devon's stock next year, especially if crude continues its OPEC-inspired upward momentum.
Worried without reason
Pioneer Natural Resources' stock has fallen about 13% this year, with most of that damage done following its disappointing second-quarter report. Investors bailed on the shale driller after it revealed that a drilling problem slowed its pace and that its wells were producing more natural gas than expected. Investors misread that latter issue, thinking that the company was producing less oil and more gas, which wasn't the case since oil remained on target. Instead, wells delivered more production than expected overall, driven by higher gas output.
As such, even with the slight drilling slowdown, the company remains on pace to hit its ambitious target to increase output up to 1 million barrels of oil equivalent per day by 2026, which represents 15% annual growth for the company over the next several years. Further, Pioneer noted that it's getting closer to the point where it can achieve that high rate of growth while living within cash flow at $50 oil. Though given that oil is in the upper $50s at the moment, it's currently generating the cash flow needed to finance its plan, and it has ample financial resources to bridge the gap if crude falls back again. Either way, the company should increase production by about 15% next year, which would fuel an even higher cash flow growth rate given where crude is these days. That could provide Pioneer with the fuel to reverse its decline next year.
Repositioned to produce a gusher of excess cash
Marathon Oil is down about 14% this year despite making excellent progress on its strategy to transform into a low-cost growth company. At the beginning of the year, the company said it could increase output by a 10% to 12% compound annual growth rate through 2021 and pay its current dividend while living within cash flow as long as oil averaged $55 per barrel. However, after making further improvements to its cost structure, including exchanging its high-cost Canadian oil sands assets for a low-cost position in the Permian Basin, the company can now achieve that plan at $50 oil.
Because of that, Marathon should generate excess cash in 2018 given where oil is right now. That would be on top of the $750 million in proceeds it will receive next quarter from the final installment of its oil sands sale. Those two sources should provide the company with plenty of money to allocate on behalf of shareholders, which it will likely use to pick up more high-return drillable acreage as well as further shore up its balance sheet. That will only further strengthen Marathon's ability to excel, which should eventually enable its stock to start making up the ground it lost in 2017.
Betting on a rebound
It's surprising to see this trio of top-notch shale stocks lose so much value this year, which seems like a mistake considering that crude prices have risen even as their ability to handle lower oil prices improved. In fact, they've progressed to the point where each enters 2018 positioned to grow production and cash flow at a rapid rate even if crude slips back down to $50 a barrel. That means these oil stocks could generate a gusher of excess cash flow if crude remains where it is, with even more upside if it keeps heading higher. Because of that, these beaten-down oil stocks could rebound sharply in the coming year if oil holds up, which is why you might want to think about grabbing one before the market realizes it made a blunder by selling them off this year.
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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.