Despite a bumper quarter from ASX energy stocks, there’s still value to be found among Australian oil and gas producers according to Morningstar analyst Mark Taylor.

Taylor, who recently initiated coverage on smaller-cap oil and gas players Strike Energy (STX) and Karoon Energy (KAR), listed upstream oil and gas producers as some of the most undervalued in the ASX energy sector.

“Share prices of Australian exploration and production companies have naturally fallen from their recent highs. But even at those recent peaks, they were still largely trading below fair value, in 4- to 5-star territory,” he said.

line graph of Morningstar indexes

Taylor notes that while the record earnings posted by energy companies in 2022 won’t be repeated for a long time—spot prices are still tracking back towards ‘healthy’ midcycle levels for low-cost Australian operators.

Two companies hoping to benefit from the sector’s strong outlook are Strike Energy and Karoon Energy, which were both recently included in Morningstar’s coverage universe.

Here's how they stack up against the broader ASX oil and gas sector.

Strike shows moat potential as production nears

As the single largest holder of gas resources in the Perth Basin, Strike Energy has garnered increasing investor interest in recent years as the explorer made steps towards production.

Shares in the company hit all-time highs this month, yet Strike is still trading within fairly-valued territory, based on Morningstar’s recently initiated fair value estimate of $0.45.

For Taylor, the key question for investors is just how effectively Strike can monetise its healthy gas positions—and the outlook appears positive.

“Strike's plans are ambitious for a company with no earnings history. However, the small ASX-listed hydrocarbon explorer could soon become producer with a strategy to accelerate development of up to four gas fields by end 2025. We credit production from all four,” he says.

“Given the favourable reservoir characteristics and the enviable proximity of gas fields to existing pipelines and the Perth market, we expect the direct-to-market route will be relatively straightforward.”

However, while the company’s production potential looks strong, Morningstar has not granted Strike a wide- or narrow-moat ranking.

Moats are granted to companies which are seen to hold a long-term competitive advantage over their peers, but Taylor says it is too early to determine whether Strike will meet this threshold.

“We consider it premature to award a moat to a company which is yet to achieve producer status and which has no project delivery track record.”

“It may have the foundations for the making of a moat. But we need to see tangible evidence first.”

Strike Energy (STX)

  • Star Rating: ★★★
  • Fair Value Estimate: $0.45
  • Uncertainty rating: Very High

Expansion marks next test for Karoon Energy

Trading with a similar market cap to Strike Energy, oil producer Karoon Energy is in the process of doubling the annual output from its Bauna oil field in South America.

Karoon bought into the asset back in 2020 and, to the company’s credit, Taylor says the timing of the purchase during a price lull was impeccable.

“The asset has many redeeming features including simple and efficient infrastructure, excellent reservoirs, and a production growth runway,” he says.

But as a single asset company with limited operating experience and high sovereign risk due its Brazil asset centre, Taylor says the company’s next test will be to continue to expand Bauna, while also maintaining discipline in pursuit of a second Americas asset.

“Successful operatorship and improvement at Bauna over the past couple of years to date is cause for optimism. So too is the focus on value-accretive opportunities,” he says.

“In the bigger picture, Bauna is probably past its prime with cumulative production of around 120 million barrels of oil prior to Karoon's acquiring it.”

“But the asset is well located with excellent reservoir characteristics and simple and efficient infrastructure in Brazil's Santos basin. There is still meaningful life and growth potential for a company of Karoon's size,” he says.

Shares in Karoon Energy are trading close to Morningstar’s fair value estimate of $2.30.

Karoon Energy (KAR)

  • Star Rating: ★★★
  • Fair Value Estimate: $2.30
  • Uncertainty rating: Very High

Beach Energy: An undervalued energy stock

For investors seeking an undervalued oil and gas company, Taylor points towards Adelaide-based oil and gas producer Beach Energy (BPT), which screens as the most undervalued energy stock in Morningstar’s coverage universe.

The explorer-producer, which supplies oil and gas to the Australian east coast gas market via its five on-shore and off-shore basins in Australia and New Zealand, is currently trading at around half its fair value estimate of $3.00 per share.

The company has traded deeper into undervalued territory in recent months and its share price is around 5% down on the year to date. Taylor attributes the poor share price performance to market concerns surrounding the life of Beach’s producing assets.

“We forecast strong EPS growth for Beach, but the market may be penalising it for lesser field life. While some life discount is warranted, we think the current level is too harsh,” he says.

And with higher domestic production on the horizon, Taylor says the market may have misjudged this producer’s outlook.

“The commissioning of Perth and Otway basin projects, with their attendant increased volumes, are the most likely catalysts for price appreciation to fair value,” he says.

“Beach's comparatively high proportion of domestic gas production blunts the impact from anticipated decline from export commodity prices.”

Beach Energy (BPT)

  • Star Rating: ★★★★★
  • Fair Value Estimate: $3.00
  • Uncertainty rating: High

The full Q2 2023 Outlook, which details Morningstar’s best stock picks across all sectors, is available to Investor subscribers.