MIZUHO SECURITIES USA INC. | US EQUITY RESEARCH
After two weeks of meetings/calls with clients following our recent launch, we present our summary takeaways. When re-engaging with investors after having our heads down for two months, we were most surprised by the degree investors favored oil over gas through 2017. Given that mindset, investors understand our caution on valuations for Permian Basin pure-plays, but feel content to hide in them knowing they are unlikely to underperform the broader industry in anything but a sharply accelerating oil price environment. Summary thoughts on two main topics and popular / unpopular ratings are below.
It's lonely here on Gas Bull Island. Our constructive view on natural gas through '18 was met with pushback from trading-oriented and long-only accounts. The pushback is more in a relative sense - investors have a more constructive view on a sustainable 10+% increase in oil prices than a similar rally in gas. But there remains concern on gas prices, which is two-pronged. First, investors are concerned that a bounce in non-Appalachia gas production (Permian, SCOOP/STACK, Haynesville) may offset broader declines in lower 48 production. Second, investors are increasingly less comfortable with the timeline of pipeline construction projects in Appalachia, and reviewing thoughts on what they are willing to pay for gassy Appalachian producers. Our counter has been that a minor disruption in the Atlantic Sunrise pipeline does not indicate the "end of days" for all regional pipeline projects. And we remain constructive on secular improvements in natural gas demand, which we expect to keep a bid for gas in the $3/mcf range, assuming a normal winter.
Investors understand Permian caution, but are still happy to hide there. Our caution on the Permian-levered names was received favorably, with investors questioning how much more relative multiple expansion the group will merit. But with that said, many Permian operators have announced '17 guidance already that demonstrates that capital efficient growth possible in a $50/b oil world. Investors largely feel comfortable owning names where there is a high level of certainty on 2017 production/spending. We have told clients that there is no need to take a bull/bear case on Permian-focused names as a whole. But they should look at each on a bottoms-up basis, as differences in '17 growth, balance sheets and inventory depth will differentiate winners and losers. Our two Buy-rated Permian Basin names remain Energen and Diamondback Energy.
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