Time to buy these energy stocks with over 40% upside potential, analysts say

Energy stocks outperformed last year, with the sector generally gaining 59% in a year when the S&P 500 dropped 19%. That’s serious performance, the kind that will always delight investors, and it has traders and analysts alike watching the energy sector closely in this first quarter of 2023.

So far, the energy sector is holding back from the action. Inflation appears to be cooling and the Federal Reserve has indicated that it may take a slower pace for future interest rate hikes, both developments that have benefited growth stocks over cyclical shares like energy.

Looking forward, however, we’re likely to see the price of oil rise by the end of 1H23. China is reopening its economy, which will goose demand, while Russia’s exports, which were slammed when that country invaded Ukraine last year, have risen back to nearly pre-war levels. Seasonal demand increases in the US, during the northern hemisphere spring and summer, will also support prices – and that will likely be reflected in share prices.

Against this backdrop, Wall Street analysts are looking into the energy sector, seeking out stocks that are primed for gains – on the order of 40% or better. Potential gains of that magnitude deserve a second look, and we’ve pulled up the details on two such names.

TXO Energy Partners (TXO)

The first energy stock we’ll look at is new to the public markets, having held its IPO just this year. TXO Energy Partners operates as a limited master partnership, with operations in the Permian basin of Texas-New Mexico and the San Juan basin of New Mexico-Colorado. The company is focused on the profitable exploitation of conventional oil and gas sites in its areas of core operations.

TXO Energy Partners has a diverse portfolio of conventional assets that encompass different types of hydrocarbon production methods. These include coalbed methane production, which is primarily located in the San Juan Basin, as well as water and CO2 flood-based production, which is primarily located in the Permian Basin. As of July 1, 2022, the company's total proved reserves were 143.05 million barrels of oil equivalent, with 38% of the reserves being oil and 82% being developed.

The stock opened for trading on January 27. The IPO saw the sale of 5 million common units, and when it closed, on February 6, the company announced that the underwriters had exercised their option for the purchase of an additional 750,000 common shares. Overall, the IPO raised $115 million in total gross proceeds. The stock is currently priced at $23.74, for an 8% increase from its first day’s closing value.

Covering this newly public stock for Raymond James, 5-star analyst John Freeman sees its non-fracking profile as a potential net asset.

“TXO’s base decline rate [is] a true differentiator versus peers," Freeman opined. "TXO sports a peer-leading ~9% annual base decline rate, a product of its conventional asset base. This enables minimal capital investment (relative to peers) to both sustain and grow production levels (no outside financing needed to fund capex, contrary to historical E&P MLPs), translating into higher free cash flow profile versus unconventional peers.

The analyst is also a big fan of the management team, noting: "All of TXO’s management team held senior positions at XTO Energy prior to leading TXO. In fact, from IPO to XOM sale, XTO realized a ~26% annualized return, outperforming the S&P by roughly 8x during that time frame. From a technical standpoint, TXO’s management team have operated in over 15 U.S. shale basins with multiple decades of experience."

In line with this bullish stance, Freeman describes TXO shares as a Strong Buy. His price target, set at $34, suggests it has a one-year upside potential of ~43%. (To watch Freeman's track record, click here)

Turning now to the rest of the Street, other analysts are on the same page. With 100% Street support, or 3 Buy ratings to be exact, the consensus is unanimous: TXO is a Strong Buy. The $33.33 average price target brings the upside potential to 40%. (See TXO stock forecast)

Diamond Offshore Drilling (DO)

The second energy stock we’ll look at is another oil and gas drilling company, this one focused on the difficult realm of oceanic hydrocarbon drilling. Diamond Offshore operates a fleet of deepwater rigs, including both semisubmersibles and dynamically positioned drillships. The company's ultra-deepwater rig Ocean Courage was recently awarded a $429 million four-year contract project with Brazil’s Petrobras.

Diamond Offshore suffered badly during the corona pandemic period, and entered bankruptcy proceedings in April of 2020, under Chapter 11. The company completed its financial restructuring to emerge from Chapter 11 bankruptcy in April of 2021, and the DO ticker resumed public trading in March of 2022.

We’ll see Diamond’s 4Q22 and full year results tomorrow, but we can look back at its 3Q22 report for an idea of where the company stands. For the third quarter, Diamond reported its second consecutive quarter of sequential revenue increases, with a top line of $226 million. This marked a 10% gain from the second quarter, while beating consensus estimates of $181.39 million. At the bottom line, Diamond shifted from a Q2 loss of 21.9 million, or 22 cents per share, to a net income of $5.5 million, or 5 cents per diluted share in profit. This was a huge beat, as analysts were expecting a loss of 31 cents a share.

It was a strong turnaround for the company, and was supported by strong performances from the firm’s operating rigs. Diamond’s deepwater drilling rig fleet showed a 97.3% revenue efficiency overall, and the Ocean BlackHawk rig earned a performance bonus when it completed its first well in Senegal. In addition, the drillship Vela commenced an important contract in the Gulf of Mexico, and this year may see options for up to seven additional wells.

Analyst David Anderson, of UK banking giant Barclays, has taken up coverage of Diamond, and he sees the company holding a sound position to generate gains going forward.

“Following a transition year in 2022 after its April 2021 emergence from bankruptcy, we expect DO to generate significant EBITDA growth from 2023-2025 following a roughly breakeven 2022. This year will be just the first step, moving higher in 2024 and 2025 driven primarily by five rigs rolling off contract in 2024... which presents a nice repricing opportunity," Anderson wrote.

This generally upbeat stance leads Anderson to rate the stock an Overweight (i.e. Buy), with a $21 price target that implies a robust 79% upside potential on the one-year time horizon. (To watch Anderson’s track record, click here)

Some stocks fly under the radar, and Diamond is one of those. Anderson’s is the only recent analyst review of this company, and it is decidedly positive. (See Diamond stock forecast)

To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a tool that unites all of TipRanks’ equity insights.

Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
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