Downgrade Alert: Morgan Stanley Is Warning Of 50% Downside In These E&P Stocks

• Shares of Marathon Oil Corporation MRO, Encana Corporation (USA) ECA, Canadian Natural Resource Ltd (USA) CNQ and Whiting Petroleum Corp WLL have been trending lower over the last 5 trading days.
• Morgan Stanley’s Evan Calio downgraded the ratings for Marathon, Encana and Canadian Natural Resources to Equal-Weight and for Whiting Petroleum to Underweight.
• Resilient US production even under lower oil prices, coupled with international production growth are expected to extend oil’s trough through 2016, Calio mentioned.

Morgan Stanley has lowered their E&P sector view to In-Line on a weaker commodity price outlook. Analyst Evan Calio mentioned that the resiliency of global production especially US shale, the potential return of Iran and Libya to the market and the softening of demand have pushed the timing of the expected balancing in the crude market into 2017.

“We are marking our deck to strip through 2018 and cutting LT (2019+) price assumptions for Brent to $60, WTI to $57 (vs. $85 and $80 prior) and Henry Hub to $3.25 from $3.75,” Calio stated, adding that the top picks in the sector continued to be those companies that have high quality differentiated outlook and assets.

Calio mentioned that refiners have outperformed since December 2015 and are expected to continue the same way into 2017. “Our E&P sector view, ratings, and targets in 2015 were wrong and have significantly underperformed; we are resetting that today, even near lows,” the Morgan Stanley report noted.

The downgrades in rating reflect a “more protracted recovery that drives lower production and increases leverage,” Calio stated. “After E&Ps underperformed 42% in 2015 and 10% YTD, the strip is $35/Bbl and ~$2.50/MMBtu,” the analyst said. He added that a nearly 50 percent downside can be expected before the group becomes cheap.

Calio believes that the longer the down cycle continues, the market is less anticipatory of a recovery in the oil prices. “Through the next upcycle cycle, we see significant potential value,
yet timing is uncertain.”

Price Target Reductions

Marathon Oil - from $29 to $10
Whiting Petroleum - from $23 to $4
Encana - from C$10 to C$5.50
Canadian Natural Resources - from C$45 to C$30