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Fears over oil price shock overdone

Glenn Freeman  |  10 Mar 2020Text size  Decrease  Increase  |  
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Aircraft are grounded, borders are closing and oil prices are plummeting as coronavirus fears sweep global markets.

Australia's national carrier Qantas (ASX: QAN) has shuttered around one-quarter of its international flights and asked a large chunk of its workforce to take leave.

Italy's coronavirus death rate has hit 463 and new cases of the virus have emerged across Europe – in Spain, Greece, Croatia, Switzerland and Germany.

Investors reading the headlines may be tempted to hit the panic button, especially as a collapse in oil prices adds further stress to already fragile economies and markets.

But Morningstar Australia's head of equity research Peter Warnes singles out three energy stocks – Woodside Petroleum, Santos and Beach Energy – where analysts recently boosted their fair value estimates by between 12 and 14 per cent.

Woodside Petroleum (ASX: WPL)

Morningstar Rating: 5-star | Fair Value Estimate: $50 | Share Price: $22.21

Santos Ltd (ASX: STO)

Morningstar Rating: 5-star | Fair Value Estimate: $11 | Share Price: $5.04

Beach Energy (ASX: BPT)

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Morningstar Rating: 5-star | Fair Value Estimate: $2.85 | Share Price: $1.41

Energy stocks

Source: Morningstar

Warnes says investors need to separate the recent energy price falls from the companies themselves, emphasising that Morningstar's long-term valuations on these stocks aren't moving.

"And that's related not to the price of oil or LNG; it's related to production and our forward projections of the growth in production. Both are ramping up and that's driving cash flow," he says.

"I'm not saying you go fishing yet. But that's a sector that you should probably have a look at once the dust settles here because the coronavirus will pass, economies will recover, and energy is still the driving force of all economic activity."

Dave Meats, who heads up energy equities research for Morningstar US, also talks about the effect continued oil supply from OPEC countries is having on prices.

The two largest producers, Russia and Saudi Arabia, failed to agree on production cuts earlier this month, which saw oil prices drop to their lowest level since 2016.

"The resulting supply shock essentially coincides with a demand shock related to COVID-19, resulting in particularly steep price declines. And we would not rule out further weakening after the dust settles," Meats says.

He describes as "bleak" the near-term outlook for energy companies – shares in Woodside, Santos are down around 40 per cent since early January. But Meats doesn't expect these issues to extend beyond the next one or two years.

"On 26 February we argued that while the market was failing to incorporate the full impact of the coronavirus outbreak, the demand dip in 2020 would be offset by weaker-than-expected shale growth as well as prolonged OPEC cuts. But the situation has clearly evolved since then," Meats says.

He doesn’t anticipate a "supply onslaught" of oil inventory from OPEC countries, just because production caps have been loosened.

Some producers will struggle to increase oil production, or are struggling with dwindling reserves – even as others such as Saudi Arabia and the United Arab Emirates are able to increase their output in 2020.

 

is senior editor for Morningstar Australia

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