Citi Upgrades Big Oil: How To Win

After recommending caution in the big oil space for multiple years, Citi Research analyst Alastair Syme just released a new report in which the firm is finally changing its tune. After a precipitous drop in oil and stock prices during the past year, Citi now believes that integrated oil stocks are no longer overvalued and upgraded the group from Underweight to Sector Weight.

What Is The Upside?

From a value perspective, the price to book (P/B) of the integrated oil group now sits at 1.2x, lower than its troughs in both 2009 and 1998. “Assuming an 8% COE and 0% growth that would put fair value at 1.75x = 45% upside,” Syme explains.

Although risks still remain in the space, Citi now sees value-based downside protection.

Value In Oil

The oversupply in the oil market has pushed the price of oil near its effective “cash costs.”

Syme believes that oil will eventually recover to its marginal incentive price in the $65-75/bbl range and that buying oil stocks when oil is trading near cash cost provides value protection.

Path To Recovery

The return on equity (ROE) in the space is currently only 8 percent, but Syme sees a clear path to a return to ROE levels of 14 percent. Citi believes that this path consists of 20 percent contribution from cost-cutting, 40 percent growth and 40 percent price.

“The process of making these adjustments has already started; cost-cutting targets are already running at half what the industry achieved in previous down-cycles,” Syme writes.

Stock Picks

Citi’s favorite stocks in the space are those that are taking the initiative to make aggressive self-help adjustments. The firms top two U.S.-listed stock picks are TOTAL SA (NYSE: TOT) and ConocoPhillips (NYSE: COP).