Whether it is the forces of commodity cycles, the changing tides of a world economy, or even straight manipulation from the most prominent players who hear whispers from OPEC's next decision, the only certainty is that oil and gas prices are swinging hard. Crude oil has swung from below $60 per barrel in the last quarter to above $80 per barrel as of today's new quarter, and natural gas has followed a similar path.
As many traders will already know, this means that volatility often leads to the best opportunities in a market; lining up this technical factor with some fundamental logic can bring investors to arrive at the best names to invest in. As economic data portrayed in the United States ISM manufacturing PMI index shows, the industry may be in the initial stages of a new cyclical run.
A Pivoting Industry
The institute pointed to sixteen out of eighteen industries contracting within the latest PMI report (breaking down July's trends). This factor will likely have an adverse effect on quarterly earnings for stocks within those unfavored industries. The petroleum and energy derivatives industry grew the most during the month, acting as a clear outlier for investors and traders to begin drilling down for some value hunts.
As the world's economic powerhouses, namely the U.S. and China, are facing some significant turnarounds involving monetary policy, trade, and energy demand becomes the first pillar to be affected. Because China's inflation rate has been disappointing during the past couple of months, the government has implemented various stimulus measures to get consumers to spend well.
As these measures make their way down the economy, the inevitable spark in trade and demand for commodities will ultimately come into play, boosting production and earnings for a specific subset of stocks. Today, investors can save hours of research and work and contemplate a potential purchase in one - or all - of these three industry favorites.
Suppose the market realizes that the underlying industry is on the brink of cyclically heating up. In that case, certain pockets along the value chain may be commanding more attention - and investment - before others. Since the big oil names cannot respond to demand through increased production, until they secure capacity through plants and equipment, it makes sense for investors to jump into these equipment providers.
TechnipFMC (NYSE: FTI) just reported its second quarter 2023 earnings results, hinting at the clear trends portrayed in the PMI report. Within the presentation, investors will note a critical highlight. The subsea equipment order bookings brought in $4.1 billion in revenue, impressive though paling compared to the expected $9 billion total for the end of 2023.
These expectations begin to paint a clearer picture of where the company's financials - and its stock valuation - may be headed; it makes sense as to why markets are rewarding this stock with top-of-the-industry valuation multiples. Moreover, as more lucrative times are set, management has committed to distributing 60% of free cash flows back to shareholders through at least 2025.
Technip takes the crown on a forward price-to-earnings multiple, which gauges market sentiment toward the future twelve months of earnings - and their respective quality. The mid-cap oil and gas equipment industry carries an average forward P/E of only 12.2x, whereas Technip trades for a superior 16.6x, a direct reward from markets being bullish about the future.
Following the same logic as before, focusing on equipment providers can be the best bet before the whole energy industry takes off. Baker Hughes (NASDAQ: BKR) is one of the more prominent provider names, and its analyst ratings may not yet reflect the upside that markets are perceived for the stock's future.
Citigroup (NYSE: C) analysts are getting ahead of the curve, as they recently boosted the stock's price target to reflect a 17% upside from today's prices. Just like Technip, management showcased just how bullish they are for the company's near future within the latest quarterly earnings presentation, and investors should pay attention too.
Full-year 2023 order bookings outlooks were revised higher, now looking to break above the upper range of conventional expectations. These heating demand trends, and those yet to come, are also pushing the company's free cash flow levels higher to a "strong" $623 million, enabling management to repurchase as much as $99 million of stock.
Regarding the large-cap oil and gas equipment industry, an average forward P/E of 12.9x will fall short next to Baker's forward P/E of 17.5x. Again, markets expect growth and quality in the sector's earnings to come from Baker Hughes. Hence, they are willing to pay a 'premium' above competitors for exposure to these future trends.
Targa Resources (NYSE: TRGP) comes to provide an idea for diversification into a potential portfolio, as the company focuses more on the midstream and logistics side of the industry, where earnings will trickle down after money cycles through the equipment providers above. It seems that analysts are actually aware of this, and ahead of time for this round.
Targa analyst ratings are pointing to a consensus 21% upside potential from today's prices, which makes sense considering that money has yet to make its way to this pocket. Despite being in a different niche, the story remains the same; however, growth and management investment remains the law of the land within the latest quarterly presentation.
A quarterly record share repurchase program of $149 million was deployed by management, a subtle vote of confidence from insiders themselves into the future outlook and potential undervaluation today. While there was a lack of guidance raises, which were the highlight of equipment providers, markets still favorably rewarded this stock.
The large-cap oil and gas midstream industry carries an average forward P/E ratio of 11.9x, and Targa is trading right along this average at 12.0x. Investors need to take away here that double-digit upside consensus from analysts, alongside aggressive buybacks, is pointing to a brighter future ahead, in which markets may wake up to reward this stock upon quarterly releases.