Two lasting ‘truths’ of the oil business no longer apply, according to Barclays Capital, which has today upgraded its view on the sector due to improving conditions in the crude market.
“After a decade covering the European E&Ps, we believe two long established ‘truths’ have dominated sector sentiment: (1) E&Ps will reinvest cash flow rather than return it; and (2) spot commodity prices have a disproportionate influence on market valuations,” analyst James Hosie said in a note.
READ: Tullow Oil nudges up production guidance
“Our base case outlook essentially assumes neither of these “truths” are still valid - valuations remain anchored to a long term oil price of $65/bbl and companies prioritise returning cash over reinvesting it.”
Barclays now increases its sector view to ‘positive’ from ‘neutral’.
Along with the sector view rising, Barclays also upgrades EnQuest Energy PLC (LON:ENQ) and Tullow Oil PLC (LON:TLW) both to ‘overweight’ from ‘underweight’.
“Both stocks benefit materially from our higher oil price expectations for 2019-20 and are trading at a relative discount to peers,” the analyst added.
EnQuest
Barclays has a 58p price target price for EnQuest, suggesting some 60% upside to the current price of 36.05p.
Hosie said: “The stock is highly levered to the oil price outlook, and we therefore expect it to outperform its peers in this improving oil price environment.
“The company can generate material free cash flow in 2019-20 at $80/bbl oil that enables it to accelerate debt reduction and pursue new investment opportunities in the UK North Sea.”
Barclays has an upside case valuing EnQuest potentially at 100p whilst the bank’s downside case is set at 24p.
Tullow Oil
For Tullow, Barclays has a 285p target, which suggests a 21% upside to the current price of 234p.
The upside case sees a price of 375p versus a downside case pitched at 210p.
Breaking down his view, Hosie said: “Tullow is generating free cash flow and we see this accelerating over the next two years as it increases production in Ghana.
“We believe the improving financial position means management has the financial flexibility to increase investment and return cash to shareholders from 2019 onwards.
“Progress with sanctioning its East African projects is also critical.”