2024 Small and Mid-Cap E&P Outlook


We believe that the pullback in the space over the past two months offers some attractive opportunities. While oil fundamentals have weakened into 2024, we believe that the equity sell-off is overdone given 2024 strip valuations and ongoing, but lower, free cashflow and expected return of capital to shareholders in 2024.

On the natural gas front, near-term fundamentals have weakened with high storage levels, stubbornly high US production, and a mild start to the winter heating season in North America and Europe. While the startup of some US LNG projects have been pushed out from late 2024 to early 2025, the structural improvement expected in natural gas over the coming few years remains intact, providing an opportunity to accumulate in low-cost gas names like AAV and/or names generating above industry FCF levels like VET from its European gas exposure.

The gap between small cap and large cap E&P valuations has widened further this past year, a trend that started in mid 2021. We believe that this gap should not widen further given that small caps are trading at 2.0-3.0x, with lower debt levels and improved return of capital profiles being established relative to 2021, when the valuation gap began to widen. We believe that this does create some attractive opportunities in the small cap space, especially KEC, which offer similar longer-term shale growth, infrastructure ownership, and gas marketing arrangements like many large caps and HME, which offers balance sheet strength, FCF generation, and well funded return of capital strategy. 

Recent Weakness Creates Some Opportunities
Outside of the lower return of capital from lower commodity prices, the structural underpinnings of the business models have not changed and the sector remains one of the better value-oriented sectors within the broader market. Structural drivers include capital discipline generating moderate production growth and return of capital to shareholders (albeit at lower expected levels in 2024) with healthy balance sheets, and expectations for more consolidation in the shale space. 

Small Cap Ideas
We believe that the widened valuation gap between large and small cap names in energy creates some interesting opportunities with our favorite names remaining KEC and HME, with SGY also attractive for more conservative investors. 

Dividend Ideas
We believe that CJ (11.5% dividend yield) should be sustainable and offers an attractive yield. Combining dividend yield and valuation, SGY and HME are attractive.

Large Cap Ideas
For names covered in this report, we continue to like VET near-term despite the weakness in the spot given VET’s 2024 strip valuation of 2.5x, FCF yield to market cap of 25%, and expected doubling of buybacks in 2024 to 6% of shares out. 

Industry Trends
Key industry trends in this report include pickup in openhole multilateral play in the Manville, shift towards organic growth at divcos, inflation costs leveling out on the opex front, expectations for reduced 2024 industry buyback activity, expectations for negative revisions to industry 2024 CF estimates, pickup in shale M&A, greater access to equity and debt markets, expected reduction in local gas and heavy oil price volatility with improved takeaway, and a widening valuation gap between large and small cap E&P names. 

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