A Petroleum Pair Trade: Precision Drilling Vs. Sanchez Energy

Simmons & Company, energy specialists of Piper Jaffray, presented a pair trade as it updated its replacement value templates for its land drilling and SMID-cap universe.

Pair trading is an attempt to make profit out of any market conditions by going long on a stock and simultaneously going short on another that have either correlations or divergences.

As such, Simmons & Company upgraded shares of Precision Drilling Corp (USA) PDS from Neutral to Overweight and raised the price target from $3.60 to $4.25.

Meanwhile, the firm downgraded shares of Sanchez Energy Corp SN from Overweight to Neutral and lowered its price target from $14 to $6.

At the time of writing, shares of Precision Drilling were up 0.70 percent at $2.89, while Sanchez Energy was slipping 1.23 percent to $4.41.

Precision Drilling is For The Patient And Oil Bulls

Analysts John Daniel and John Watson are of the view that the only premise on which investing can be done in companies with undifferentiated, asset-intensive businesses and inferior returns on capital over time is by being constructive on oil prices.

"A nuanced or range bound outcome for oil prices will result in these discounted enterprises as being value traps and a bearish outcome will yield additional downside and continued relative underperformance," the analysts said.

Simmons & Company said, for oilfield service company Precision Drilling, which screen attractive on RV, it is not making an implicit call that its stock should rally quickly simply on an NAV valuation basis, as it believes there remains a wide range of outcomes for 2018.

The firm believes stocks trading below their RV and having no near-term debt maturities should be viewed as tactical purchases by those who are patient and believe oil prices have a higher trajectory over time.

See also: Imperial Initiates Coverage Of Oil & Oilfield Services Companies

Sanchez Energy's High Leverage

Meanwhile, the firm said following its downward adjustment of price target for Sanchez Energy, it offers about 35 percent upside to its price target/NA, above the average group potential.

However, despite the upside potential, analysts Kashy Harrison and David Kistler believe the company's leverage is well above peers increasing the risk profile should commodity prices decline. The analysts also noted that Sanchez Energy's EBITDAX multiples screen above the small-cap non-Permian peer group, which makes for a more challenging risk/reward proposition.

Simmons & Company believes a higher commodity price and large divestitures are needed to materially address leverage concerns. If the forward commodity prices move higher, the firm believes the company's shares offer substantial upside potential as it could then redeploy incremental cash flow/capital to the drillbit to generate robust organic production growth and accelerate asset value.

As such, the firm lowered its 2017 and 2018 earnings per share estimates for Sanchez Energy, with the new estimates below the current consensus estimates.

Related Link: Oil ETFs Are Getting Interesting Again
Posted In: David KistlerJohn DanielJohn WatsonKashy HarrisonSimmons & CompanyAnalyst ColorLong IdeasUpgradesDowngradesPrice TargetCommoditiesTop StoriesMarketsAnalyst RatingsTrading Ideas