After a big plunge below that technical level, the stock of Permian O&G producer Pioneer Natural Resources (NYSE:PXD) has lately popped back to its simple 200-day moving average, down 20% or more since June.
However, over the previous 60 days, consensus EPS projections increased by $0.30/share despite the stock’s decline. This is fantastic news for investors because Pioneer is a very shareholder-friendly business. It aims to pay out up to 75% of free cash flow while maintaining discipline and increasing production at a reasonably slow (5%) rate.
The company’s balance sheet is quite robust and prepared for any future decline in O&G prices. As a result, I’m changing my rating on PXD from HOLD to BUY, and I anticipate the company to close the year above $250 while producing outstanding dividend income. PXD may very well achieve a total return of 20% by the end of the year.
Investment Thesis
Most of you are already aware of the current bullish macro climate for oil and gas producers: In response to Putin’s dreadful and unprovoked attack on Ukraine, the United States and its Democratic and NATO allies imposed oil sanctions. These advances, along with the strict production growth policies of OPEC and U.S. shale producers, have led to a tightening of the oil and natural gas markets worldwide.
While the price increases have been terrible for consumers (particularly those in the E.U.), they have come as a surprise to long-suffering O&G investors. Before COVID-19, the oil sector’s returns had been dismal, driving away many investors. Barron’s noted this weekend that “Energy Stocks Punch Above Their Weight In Earnings,” which is why I think that despite making up only 4% of the S&P 500, energy firms are predicted to provide 12% of the index’s earnings in the second quarter.
Concerning Pioneer Natural Resources, this very definitely seems to be the case. Look at the most recent consensus profit forecasts:
As previously indicated, despite the stock’s recent decline, the Q2 EPS projections increased by $0.30/share to $8.80. The full-year projection has increased to $33.12 from over $3/share. The $217 stock price as of this time translates to a (six-month) forward P/E of just 6.6x. That is precisely one-third of the average S&P 500 P/E of 19.8x. I’m now sufficiently confident of the PXD prognosis to alter “could pay” to “will pay” more than $20 per share in dividends.
Earnings
According to the Q1 EPS report, PXD earned $2.3 billion in free cash flow and returned $8.8 billion to shareholders through $250 million (11%) in share buybacks and the remainder toward basic and variable dividends, giving PXD stockholders a total dividend income of $7.58 per share. I certainly wish ConocoPhillips (COP) would adopt that ratio of buybacks to dividend payouts rather than dividends, which that firm greatly overemphasizes.
PXD’s return on capital employed in Q1 was higher than 30% due to exceptionally disciplined capital management. Given the strength of the oil and natural gas prices, I predict PXD’s ROCE to be much higher in Q2. It should be noted that the price of natural gas increased dramatically between Q2 and Q1.
For PXD stockholders, this is crucial because the business produces a sizable amount of associated natural gas from its Permian wells in the Midland Basin. According to the graph below, PXD produced 55.6% of all oil in the first quarter.
That means that 44.4% of PXD’s output was made up of natural gas and NGLs and that Pioneer will benefit from the increase in natural gas prices in Q2 as a result of more vital LNG exports and robust natural gas demand for power generation during a scorching summer (and likely for some time to come).
Moving forward
PXD could distribute an estimated $8 billion in dividends this year, or $31.29 per share based on the 256 million fully diluted shares reported at the end of Q1, using the earlier estimate of $9 billion in FCF and the Q1 payout ratio of approximately 11% allocated to the buybacks and 89% to dividends.
Given the 20+ year supply of quality Permian Basin drilling areas that break even at less than $40/bbl WTI, PXD is in a strong position for the long term.
Risks
The global supply/demand balance, which the global economy can impact (high prices and/or a recession equal demand destruction), as well as supply (i.e., increased production by U.S. shale producers and/or OPEC), is a risk when investing in a commodity producer (and commodity price taker) like PXD.
PXD’s balance sheet seems strong; at the end of the first quarter, it had $2.4 billion in cash and only $3.3 billion in net debt. Pioneer anticipates bringing its net debt to EBITDAX down to 0.15x by year’s end and has enough liquidity ($4.4 billion). Given this situation, I believe PXD is ready and well-positioned for any significant decline in O&G prices.
Summary and Verdict
My original estimate of Pioneer Resource’s dividend per share was substantially too low. This, together with a recent drop in the share price as Q2 and FY22 profit consensus estimates increased noticeably, has convinced me to upgrade PXD from a HOLD rating to a BUY rating. I believe PXD is incredibly undervalued at this point and will conclude the year trading above $250 a share.
Over the following six months, investors might anticipate a total return to investors of 20% (or perhaps greater) when combined with the anticipated dividend payouts (base + variable). On August 8th, after the market closes, the Q2 report is expected to be released. I advise investors to start holding PXD before that report. Since Q2 will probably be fantastic, I anticipate management to increase guidance moving ahead.
Featured Image: Megapixl © Rafaelhenriquepress
