Energy Stocks Rally as United States Inventory Grows

01/22/2016 10:00 am EST

Focus: ENERGY

Michael Berger

President & Founder, Technical420.com

Since he sees value in several energy stocks after recent declines, Michael Berger, of Technical420.com, offers five reasons for why he's favorable on shares of this one in particular at current levels.

Global equities continue to move higher on speculation that central banks will expand stimulus measures to counter the recent sell-off in financial markets. The potential for further stimulus has turned market sentiment around and this is important because in this month alone, approximately $8 trillion has been erased from the value of global equities.

After European Central Bank President Mario Draghi said that monetary policy will be reviewed as early as March, the price of crude is poised to have its steepest two-day rally in five months. Friday, President Draghi reiterated this statement at the World Economic Forum in Davos, Switzerland.

This rally comes after a rough week for oil companies. On Wednesday, the price of WTI Crude broke below $27 a barrel for the first time since September 2003, trading as low as $26.55 a barrel. This drop left WTI down an incredible 28% in 2016.

Energy Stocks to Rally as Inventory Grows

The energy sector has seen heavy weakness since the start of the new year; the Energy Select Sector SPDR ETF (XLE) is down more than 10% during 2016. Thursday, XLE broke out of oversold territory and shares are up 7% from its lows on Wednesday.

The rally in oil prices comes after the United States Energy Information Administration (EIA) announced that crude inventories rose by 4 million barrels in the last week. This is much higher than the EIA's estimate of 2.2 million barrels, as well as Wall Street's 2.8 million estimate. United States crude oil inventory is at its highest level since 1990.

Stocks to Watch

Although this situation will most likely get worse before it gets better, especially after Iran's Deputy Oil Minister said Iran will increase oil production by 500,000 barrels a day, we see value in several energy stocks after recent declines.

One of such stocks is Concho Resources, Inc. (CXO), which is down 12.5% during 2016. Thursday, CXO broke out of oversold territory after shares rallied more than 12%. CXO is our favorite exploration and production company due to 1) its premier asset base in the Permian basin, 2) CXO is well-positioned for another beat-and-raise performance during 2016, 3) balance sheet offers capital flexibility, 4) proven acquisition model, and 5) attractive valuation.

Investment Thesis

Over the last several years, CXO has been able to beat production and cost expectations on a consistent basis. We do not expect this theme to end during 2016. In fact, we believe that CXO will highlight its best-in-class operational capabilities. During 2015, CXO was able to grow north of 25% despite spending $1 billion less than it had initially planned to deliver that growth.

CXO owns 535,000 net acres in the Delaware Basin/New Mexico Shelf (in the Permian basin). We believe the rate of change in the Delaware basin (improving estimated ultimate recovery and costs per well) will be the highest. During 2016, we expect to see meaningful improvement in the type curve and cost efficiency gains.

Also, we think current acreage prices are understated in the Delaware basin relative to the Midland basin (Midland is $20,000 more per acre). Over the next year, improving economics and increasing M&A activity should narrow the gap between acreage values. Due to the size of CXO's acreage position, this will further strengthen the company's balance sheet.

The weak oil and gas price environment has made financial flexibility more important than ever. The only way a company can be financially flexible is by having a balance sheet to support it. CXO has a solid balance sheet with net debt/EBITDA of 1.7x. CXO also recently completed a $794 million equity offering to fund acquisitions. This raise provided the company with around $500 million in borrowing capacity.

During the last three months, CXO has fallen more than 27% and shares have outperformed the Oil Exploration & Production Index (EPX) which is down more than 39%. CXO has fallen 40% from its highs in July 2014 (traded as high as $148.30) and we see value in shares at current levels.

Michael Berger, Founder and President, Technical420.com

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