Energen Vs. Range Resources: A Commodity Pair Trade From Morgan Stanley

Exploration and production companies are likely to update investors in their first-quarter reports on budgets and returning cash to shareholders, according to Morgan Stanley. 

The Analyst

Morgan Stanley's Evan Calio. 

The Thesis

The upcoming earnings season will likely show E&P companies are taking a more disciplined approach to their capital spending and embracing a growing trend of returning cash to shareholders, Calio said in a Wednesday report. (See the analyst's track record here.) 

Morgan Stanley announced the following two ratings changes: 

Energen Corporation EGN was upgraded from Equal-weight to Overweight with a price target boosted from $56 to $75.

• Range Resources Corp. RRC was downgraded from Equal-weight to Underweight with a price target lowered from $17 to $14.

Energen: Improved Execution

Energen's stock will likely move higher as investors recognize management's improved execution, rising capital efficiency and a quality asset base, the analysts said. The Birmingham, Alabama-based company boasts a best-in-class balance sheet, which gives the stock downside support, Calio said. In an environment of rising oil prices, the balance sheet could be tapped to take part in a consolidation trend that's expected to start later this year, he said. 

Energen's stock multiple of trading at a three-turn discount to its Permian peers on a 2018 EV/EBITDA basis implies it is a "vastly lower quality" compared to its peers, the analyst said. This thinking is "inaccurate" given the company's strong exposure in the Delaware and Midland basins; low leverage among its peers; and above-average debt-adjusted production per share growth, Calio said. 

Range Resources: Few Positive Catalysts Ahead

Despite boasting "high quality" assets, Range Resources' stock offers investors a "weak" risk-to-reward profile, according to Morgan Stanley. Calio named six reasons to avoid the stock:

• A weak natural gas outlook.
• A slowing growth profile. 
• A lack of confidence in the management team.
• Challenges to reduce its high leverage.
• An already "frustrated" shareholder base.
• Concerns over its core assets in Terryville.

The most notable catalyst for Range Resources, a reset in gas prices, won't materialize until the 2018-2019 heating season, Calio said. Other catalysts, including the sale of its Mid-Continent (Oklahoma) and Northeast Pennsylvania positions, could only result in a "modest reduction" of its leverage to a high 2x range, according to Morgan Stanley. 

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