KLR Downgrades 3 E&P Names On Valuation Concerns

The price of crude oil rose 7.5 percent in the first quarter, creating a setup for a better quarter at exploration and production companies. It's against this backdrop that KLR Group reviewed the sector's performance in a Wednesday note. 

The Analyst

Analyst John Gerdes downgraded Continental Resources, Inc. CLR, Pioneer Natural Resources PXD and Sanchez Energy Corp SN from Buy to Hold. 

KLR's price targets for the stocks are as follows: 

• Continental Resources: $67
• Pioneer Natural Resources: $212
• Sanchez Energy: $3

The Thesis

The E&P industry's cash capital intensity has "largely," stabilized, though it remains 45 percent below the 2014 cyclical peak, Gerdes said in a Wednesday note. The industry's overall unleveraged cost structure is expected to remain around the same levels as in 2017, the analyst said.

"Approximately three-quarters of the lower cost structure is related to capital intensity" in the form of service cost deflation and development rationalizatino and evoluton, Gerdes said. The analyst attributed one-quarter of the lower cost structure to unleveraged cash expenses.

KLR reduced its long-term Brent and NYMEX oil price forecasts by $2 and $1.50, respectively, to $65 and $61, implying a slightly narrower Brent/WTI spread and the integration of further modest improvement in global/U.S. capital intensity.

At the same time, KLR raised its 2018 Brent and NYMEX oil price forecasts by $1.32 and $2.24, respectively, to $66.32 and $62.24.

The firm's 2018 NYMEX gas price estimate was lowered by 10 cents to $2.90 and the midcycle outlook was dropped by 10 cents to 3.15, reflecting the improvement in gas industry cost intensity.

Continental Resources stock has appreciated about 30 percent since its late-February upgrade, Gerdes said. For the first quarter, the analyst expects the company to report earnings per share of 77 cents and cash flow per share of $2.18.

Pioneer Natural shares have added 15 percent since early April, the analyst said. The firm estimates EPS and CFPS of $1.69 and $4.54, respectively, in Q1.

KLR attributed its downgrade of Sanchez Energy to valuation. Sanchez is likely to report Q1 EPS and CFPS of 6 cents and 92 cents, respectively, Gerdes said. 

The Price Action

• Continental Resources is up 17.3 percent year-to-date and was up 2.9 percent Wednesday at the time of publication.
• Pioneer Natural is up 11.9 percent year-to-date and was up 1.24 percent Wednesday.
• Sanchez Energy is down 31 percent year-to-date and was up nearly 9 percent Wednesday.

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