CPE - Make Good Money In 2023 With These Stocks

Summary

• Investors can make solid profits by playing the big macro picture.
• Timing is important; when to buy, when to sell and when to stay out of the market.
• Small-cap stocks are poised to perform strongly in H1 2023.
• Be wary of resurgent inflation in H2 2023, but that too will throw up more bargains.

Introduction

Most stock gains and losses come from macro trends, rather than from company specific events. So, get the big picture correct and the rest will look after itself. But such an approach isn’t easy. It requires a lot of patience and periodically investors may even have to stay completely out of the market.

In this article, I will quickly review the macro trends of the recent past, then move onto identify macro trends for 2023 and finally provide rationale supporting what I believe are three very good stocks for 2023.

Over the past three years, I made specific buy recommendations in accordance with the prevailing macro forces. For verification purposes, here are details of the macro events and a reference to the relevant Seeking Alpha article/s:

1. In early 2020, the COVID-19 lock-downs, and associated stock market correction, created a tremendous buying opportunity in previously highly valued growth stocks. Ref Attn Value Investors and More Growth Stocks .
2. In summer / autumn 2020, as we saw some potential improvement to the COVID-19 story, investors piled into stay-at-home and various tech stocks driving valuations to stratospheric levels. Meanwhile, traditional sectors such as the major banks were shunned, as were oil stocks which had been hammered by ultra-low oil prices (and briefly negative pricing). Ref Lockdown Ending .
3. During 2021, as global economies continued their post-COVID recoveries, the market threw up lots of amazing bargains in the oil sector which had still to reflect the recovery picture. Ref 3 Stocks to Double and Another Stock To Triple and My 3 Top Picks .

These articles covered 20 separate buy recommendations, and the average maximum gain was 182% . Obviously, a fantastic headline result but, admittedly, it is virtually impossible for investors to score the maximum possible gains on all these stocks. Still, it goes to show, that even allowing for slackness, investors could achieve attractive gains just by sticking to the underlying macro trends.

The Macro Trends For 2023

Now it’s time to identify the macro trends for 2023 and see if new investment opportunities exist. Having read and listened to many sources I’ve adopted the following views:

• Inflation to fall from 9% to 4% by mid-2023.
• The first half of 2023, with inflation falling, will be good for investors.
• Improving global economies, with the help of a tail wind from China, will boost commodity prices, especially oil by mid-summer.
• In the second half of 2023, the Fed will have a quandary. Will it continue to be vigilant in pushing inflation from 4% to 2% or will it take its foot off the gas? Both options open the door to the risk of upsetting equity markets, especially if inflation ticks up again.
• In summary, expect strong equity markets in the first half and difficult times in the second half. All of this is very much in line with comments from Barry Knapp.

Top Investment Ideas For 2023

The best stocks for 2023 must be head-turners in a sea of sameness and, above all, must deliver exceptional returns for investors.

Against a tide of improving oil prices, the best value on my radar screen lies in the shale E&P sector. The whole E&P space is fundamentally undervalued, largely because of recession fears already priced-in, and because, eventually, the entire sector will become obsolete albeit that such an eventually is logically several years, if not decades, away. Behold, oil is the new cigarette!

Looking deeper within the shale sector there is a coterie of companies that offer investors even more compelling value. These are small cap companies that, until now, have had high levels of debt thus crimping shareholder distributions. I use the words ‘until now’ deliberately because, through strong cash generation in 2022, these companies made good progress in reducing debt. But it is with further strong cash generation in 2023 that these entities effectively wipe out any concerns about borrowings – and thereby they become significant dividend payers. Going from a company that cannot pay a dividend to one that comfortably returns 8% or 10% to shareholders is a major change.

Coincidentally, according to Bank of America , small cap stocks are now the cheapest they’ve been in 20 years. Further supporting views can be read from respected Seeking Alpha contributor, Josh Young .

A Word About Oil Production, And Oil Prices

Since the early 2000s total shale oil production in the USA has grown from zero to over 7 million barrels per day. It is remarkable that the global market has absorbed this much oil and that oil prices are still in the $75-$80 a barrel range. How much higher would oil prices be without shale?

Large-scale oil production from shale won’t last forever.

Already there is talk that shale output is about to peak, that it may start to decline in a few short years’ time and that E&P companies are reluctant to boost production because they will run out of drilling runway sooner than would otherwise be the case. Ref; Oil Production Slowing in the Shale Patch . According to Scott Sheffield, Pioneer CEO, many companies are now drilling tier 2 and tier 3 acreage . And John Hess, CEO of Hess Corp, warns of imminent production challenges in shale.

Investment in conventional oilfields has fallen dramatically in recent years. Given the long lead time between drilling and production it is safe to say that a major production increase from conventional fields is not on the table.

Besides, we have OPEC+ content to maintain an oil put when oil falls below $80 – and even the Biden Administration is happy to buy oil to replenish the SPR if oil goes as low as $70. And then there are the perennial outliers of Venezuela and Iran. Venezuela needs serious up-front investment and expertise, but from where? And Iran knows that their negotiating hand is stronger when oil prices are higher – therefore they are unlikely to give away nuclear concessions until such time as oil hits something like $150 a barrel.

All told, oil is well supported in the recent $75-$80 range, even with China still needing months to recover from total lock-down. Looking to 2023, it’s easy to see oil averaging $100 a barrel although we may expect some softness early in 2023 during the spring maintenance season. Refer Amrita Sen recently on CNBC.

More oil reading, many useful insights:

Revisiting The Oil Bull Thesis, Part 1 | Seeking Alpha

Revisiting The Oil Bull Thesis, Part 2 | Seeking Alpha

Three Super-Cheap Shale Companies

In the table below I’ve run provisional 2023 numbers for three small cap shale operators: Callon Petroleum ( CPE ), Vital Energy ( VTLE ) and Permian Resources ( PR ). All three are E&P companies mostly operating in the Permian Basin. The estimates are my own and incorporate; (1) current production volume trends for each company, (2) company guidance, (3) existing hedge programs as at end of Q2, ’22 and (4) hikes to P&L costs and capex to reflect recent inflation. I plan to tweak the numbers after the companies in question detail their 2023 operating plans as part of their Y/e 2022 earnings release.

All the main workings use what I consider to be a conservative $80 oil price for 2023.

Observe the boxed data at the bottom of this numeric exercise – this shows select data under a $100 oil price scenario. In my view, the market is ripe for oil to rise above $100 and these ultra-cheap stock valuations cited here will come into view.

Note in particular the very low Debt/EBITDA of just 0.5 for Callon, 0.6 for Vital and 0.5 for Permian Resources.

Also, the EV/EBITDA for all three companies is well below 2.

These are stunning numbers and pave the way for the stock prices to move much higher. I expect gains of 50% or more for all three stocks in the coming months.

Note that Callon, in their Q3’22 earnings conference call , confirmed that they will start shareholder dividends and/or buy-backs when they achieve a Debt/EBITDA of 1.0. This would be achieved by year-end 2023 if oil averages $80 a barrel, or much sooner with a higher oil price as I expect.

Keep an eye on tax. Virtually all E&P companies are sitting on large tax NOLs and hence they won’t pay cash taxes for some time, potentially years in some cases. However, this topic should receive increased airtime as more and more companies generate huge profits and thereby burn up their NOLs. I do not have hard NOL numbers for the three companies, but I did notice that, as of September 30, 2022, Permian Resources’ Balance Sheet had zero cumulative shareholder deficit and, without better information, I use that as a NOL proxy.

I mentioned that the declining quality of acreage is becoming topical. Hence, it’s increasingly important for shale operators to have an adequate runway of drilling inventory. Callon and Permian Resources both have a robust 15 years drilling inventory whereas Vital has only 10 and will ideally need to buy more.

When To Buy

Frequently, investors aim to buy shale oil stocks in periods of market weakness such as during the spring or fall refinery maintenance season. The reason being that, with significant refining capacity offline, maintenance causes oil inventory numbers to spike, sometimes sharply. Spring maintenance occurs mostly in February whilst the fall maintenance spans October and November. Using this as a backstop it may be best for investors to buy shale stocks anytime over the next few weeks. That said, if and when weakness does occur, I wouldn’t try to catch the bottom – excellent value disappears quickly.

Don’t Forget To Sell

It’s unusual to discuss selling before actually buying but there is a time to buy and a time to sell – and knowing when to lock-in profits is critical to making long term gains.

Within the global oil business there are seasonal factors that investors should watch.

The majority of motor vehicle usage, farming, haulage, airline travel and general transport occurs between spring and late summer. This attribute will give impetus to higher oil prices in summer.

But rising commodity and oil prices around mid-year run the risk of again lighting the inflation fuse. In late summer 2023, these inflation concerns may jolt equity markets. In the face of these worries, I would expect some investors to lighten up their holdings during Q2 earnings season – from mid-July to mid-August. That of itself would cause stock prices of small cap oil shares to pull back.

Therefore, to lock-in profits and avoid this market risk I would aim to cash out oil shares in late June or beginning of July. In any event, you can be sure that some market volatility will remain with us in H2 2023 and, consequently, more attractive buying opportunities will come along.

Remember, always do your own research.

Carpe diem.

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