Energy has been one of the best-performing assets so far this year. YTD, oil is up 51%, while natural gas is up by 36%. Both have reversed all of their losses following steep declines upon the onset of the coronavirus in February and March of 2020 and are now approaching 5-year highs. 

Despite these gains, we are still not seeing a meaningful supply response. CAPEX in the sector has been trending lower since 2015 and completely collapsed during Covid. This past weekend, OPEC couldn’t agree on supply increases. At the same time, demand has been quite strong despite restrictions and reduced economic activity in some parts of the world. Based on the experience of countries that are leading in vaccinations, demand will only increase as case counts drop.

Therefore, it’s likely that oil’s bull market continues, until we start to see a significant supply response. The biggest opportunity may lie in very cheap, small-cap energy stocks such as Vista Oil & Gas (VIST), Vaalco Energy (EGY), and Geopark (GPRK), which could have the most upside if energy prices keep trending higher.

Vista Oil & Gas (VIST)

VIST is a Mexican-based oil & gas exploration and production company that primarily operates in Latin America. The company IPO’d in July 2019 when oil was just under $60 at $11 per share. Currently, shares are trading at $3.14 which is a significant discount.

However, the company’s fundamentals are improving as it’s expected to be profitable as long as oil stays above $60 with its cost of production around $45 per barrel. In its last quarter, the company produced 34,000 barrels of oil per day which was an 11% increase from the previous quarter and a 29% increase compared to the previous year. The increase in production and rising oil price led to revenues increasing by 45%.  

In the energy sector, we are seeing strength in oil and natural gas but the exploration and production companies have lagged. For example, oil is testing its 2018 highs, while the Energy Select SPDR (XLE) is off by nearly 20% from its 2018 highs. This is even more pronounced in the small-cap stocks which tend to lag their larger brethren. However, these valuation gaps are typically rectified during bull markets and often end up in overshooting as investors become too ebullient. 

The POWR Ratings are consistent with this outlook as the stock is rated a B which translates to a Buy rating. B-rated stocks have posted an annual performance of 19.7% which is significantly better than the S&P 500’s annual return of 7.1%. The POWR Ratings also evaluates stocks by components. VIST has a Growth grade of B which is consistent with its impressive revenue growth and return to profitability in 2021. 

To see more of VIST’s component grades, click here. 

Vaalco Energy (EGY)

EGY is an oil & gas exploration and production company that is based in Houston, Texas but primarily operates off the coast of Africa. One of the reasons that I believe this bull market in energy could last longer and go further than the previous bull market in energy is that there are increased constraints to supply due to more environmental regulations. Another factor is the ESG component which is looking to influence behavior at the corporate level.

Due to these factors, I believe investors should consider E&P companies that are operating in countries with fewer environmental regulations as these deposits may be the easiest to access. Offshore drilling activity should increase as oil remains above $70 and could accelerate if oil continues trending higher.

EGY is also quite cheap as it has a forward P/E of 2.5 despite this low valuation, it’s expected to grow earnings by 59%. Like a lot of E&P companies, it’s priced as if the increase in oil is transitory, however, I believe this is mistaken based on the current supply & demand picture.

The POWR Ratings are constructive on EGY as it is rated a B which translates to a Buy rating. The POWR Ratings are calculated by weighing 118 different factors, each with its own weightage. EGY also has strong component grades including an A for Momentum. This is due to the stock’s recent strength as oil has climbed nearly 20% over the past month. 

To see more of EGY’s component grades, click here.

Geopark (GPRK)

GPRK is a Canadian-based oil and gas exploration and production company that operates in Chile, Chile, Colombia, Brazil, Argentina, Peru, and Ecuador. The company has reserves of 124 million oil-equivalent barrels. Like VIST and EGY, the company is making the turn to being profitable in 2021, and shares have much more upside if energy prices keep trending higher.

The company was able to survive a bleak period for E&P companies over the last couple of years as prices trended lower. Its turnaround is evident in its recent report in which the company started paying a dividend, paid off debt, and increased production. 

Over the next 12 months, GPRK is forecast to generate $2.59 in EPS which gives it a forward P/E of 4.4 which is significantly cheaper than the S&P 500. If oil prices keep moving higher, then GPRK will benefit from earnings growth and multiple expansion which are the ingredients for a significant advance.

The POWR Ratings are also bullish on GPRK as it is rated a B which translates to a Buy rating. GPRK also has an A for Quality which is consistent with its management prioritizing cash flow, returning cash to shareholders, and reducing leverage.

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VIST shares were unchanged in after-hours trading Tuesday. Year-to-date, VIST has gained 51.17%, versus a 16.55% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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