Three oil shares tipped to fly

The oil industry has been adapting to life at $60-a-barrel oil after oversupply and weak demand halved prices last year. Market forces had been moving back towards equilibrium, but we may be tipping back into oversupply, warns Deutsche Bank.

Although US crude inventories have fallen, storage surplus still stands 23% above the five-year average and the moderation of US crude production has been slower than expected. Unconventional crude production has only fallen by 116,000 barrels of oil per day (bopd) and OPEC production has been rising since October. Levels of total crude oil production now stand at 9.6 million bopd.

As we hit the third quarter, Deutsche also reckons the number of US rigs will jump, so any US production declines are likely to be small. In fact, they believe US production will grow by 750,000 barrels of oil per day (kb/d) year-on-year (yoy) in 2015 and 25 kb/d yoy in 2016.

"Our Q3 forecast of Brent averaging USD60/bbl in Q3-15 suggests periods of downside below this level," says Deutsche. After falling from $64.5 a barrel last week, Brent crude is currently up over 1% at almost $63.

Source: TradingView

But there are still value opportunities in the sector. Analysts at Barclays have been keeping themselves busy and compiled a list of their top picks.

Royal Dutch Shell

Overweight, target price 2,850p

For exposure to EU Integrated Oil, Royal Dutch Shell is the apple of Barclays' eye thanks to its proposed acquisition of BG Group. In most oil price environments, the combined group will have a better free cash flow position, along with a stronger presence in LNG and deep water Brazil.

After running the numbers, Barclays is confident the new group can work with oil prices as low as $60/bbl without being reliant on a quick return to $90 oil. Shell's $2.5 billion synergy estimate seems conservative to the analysts, who see up to $1 billion of saving opportunities from LNG alone.

"Given management’s commitment to the dividend in both 2015 and 2016  implying a 6.3% yield - and the potential for further share repurchases in 2017, we see the shares as compelling value in the current environment," says Barclays.

At 1,856p, the shares have over 50% of potential upside with a target price of 2, 850p.

Ophir Energy

Overweight, target price 225p

The pessimistic sentiment surrounding Ophir's Fortuna FLING project in Equatorial Guinea, which accounts for around 40% of its tangible net asset value, provides an attractive opportunity for investors wanting exposure to the EU Exploration and Production sector, argues Barclays.

In a bid to demonstrate the commerciality of the project, the group has established a strong concept involving a low-cost partnership with Golar LNG. Ahead of project sanction, management are hoping to partly monetise their 80% interest. With oil prices as low as they are, the environment for sanctioning new development activity looks attractive, especially with Ophir's $8.50/Mcf breakeven cost and $800 million earmarked for upstream capex.

Looking beyond this flagship project, Ophir has development opportunities surrounding its 2014 acquisition of Salamander Energy, providing "lower-risk" upside to Barclays' tangible NAV.

"Our Tangible NAV of Ophir is 231p/share and the stock is trading at a 49% discount to Tangible NAV, versus a peer group average discount of 29%. The outlook for long-term LNG prices is a key driver for our valuation; we currently assume a price of $12.50/Mcf. Historically, Ophir has traded at a premium to Tangible NAV due to the scale of its exploration portfolio, something that we do not anticipate recurring in the current industry environment."

At 117p, Barclays reckons the shares could nearly double to 225p.

Petrofac

Overweight, target price 1,400p

Petrofac is poised to deliver strong earnings growth in 2016-2017, after rebuilding its backlog to an "industry leading" standard, reckon the analysts. It's this backlog and high exposure to National Oil Companies that make this a good pick for exposure to EU Oil Services in uncertain times. The analysts are even confident Petrofac will soon be able to turn its back on recent issues from its development IES business, freeing it up to focus on the Engineering and Construction business and reduce its exposure on underperforming upstream investments. Barclays values the IES business at US$1.2 billion (223p/share) on a standalone bottom-up basis, compared to the company’s own carrying value of US$1.8 billion.

"Ex-IES the company should grow strongly in 2016 and 2017, execution excepting, with the core business delivering, on our numbers, 98p/share of earnings," says Barclays. "This places the core business on just 7x P/E, despite the business having significant embedded growth already in backlog, new contract potential and it trading on an average P/E of ca.15x over the 2007-14 period."

The broker reckons the shares have over 50% upside from 923p currently to its 1,400p target price.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.