As oil prices have surged this year, energy stocks have far outperformed the broader stock market.
The Energy Select Sector SPDR Fund (XLE) has soared 45% year to date, compared to a 20% drop for the S&P 500.
Wells Fargo analysts think there’s more to come.
“Energy momentum will continue,” they predicted in a commentary.
The rally has been fueled by a renewed focus on energy security over transition to clean energy, the war in Ukraine, a strategic shift from capital intensity to cash generation, improving balance sheets and attractive valuations, the analysts said.
“Energy sector margins have improved sequentially in each of the past five quarters, while the overall market's margin trend has been flattish to down,” they said.
Also, energy stocks have outperformed during periods of rising interest rates since 2019.
“For those worried about rising interest rates, energy seems the place to go,” the analysts said.
"[On the supply/demand side] whether driven by strategic under-investment, investor demands for returns or government policy, energy supplies have been contained, and in our view likely will remain so,” they said.
And the Winners Are …
The analysts offered stock picks for four energy sectors.
1. U.S. Exploration & Production: Coterra Energy (CTRA).
“Other U.S. E&P stocks might outshine the company on the key themes for investors: cash returns, valuations, inventory depth, exposure to LNG [liquefied natural gas],” the analysts said. “CTRA offers the most optionality when combining these preferred traits in the sector.”
The analysts rate the stock overweight with a $42 price target. It recently traded at $30.41.
2. Midstream players: Targa Resources (TRGP).
“We see further upside [for the stock] tied to the high commodity price environment, potential upside to Permian volumes, an inflection point in cash return to shareholders and potential inclusion in the S&P 500,” the analysts said.
“Targa is one of the few midstream companies with meaningful direct exposure (about 20% of cash flow) to natural gas and natural gas liquids prices.”
The analysts rate the stock overweight with an $86 price target. It recently traded at $68.50.
3. Integrateds, Independent Refiners and International E&Ps: HF Sinclair DINO
“With acquisitions closed and renewable diesel expansions nearly completed, operational execution and increased cash returns to shareholders come into focus,” the analysts said. They note that the company has pledged $1 billion of cash returns to shareholders.
The analysts rate the stock overweight with a $52 price target. It recently traded at $45.83
4. Oil Field Services: Schlumberger (SLB).
Higher commodity prices, resulting from sanctions against Russia will likely have some effect.
“[They may] accelerate spending and activity expectations elsewhere, bolstering a back-end weighted forecast for the second half of 2022,” the analysts said.
“Non-North America oil field markets are poised for strong and durable recoveries through year-end 2023.”
The analysts rate the stock overweight with a $55 price target. It recently traded at $40.82.
