Morgan Stanley: Energy Stocks Set to Surge, Eyes on COP & OXY

Morgan Stanley upgrades energy sector to overweight, spotlighting ConocoPhillips and Devon Energy among top picks for sustained earnings growth.

By Bill Bullington

3/29, 08:19 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
Devon Energy Corporation
Equinor ASA
Diamondback Energy, Inc.
Occidental Petroleum Corporation

Key Takeaway

  • Morgan Stanley upgrades the energy sector to overweight, highlighting its outperformance with a 12.5% YTD rise versus the S&P 500's 10.1%.
  • Top picks for the energy catch-up trade include ConocoPhillips (COP) and Occidental Petroleum (OXY), with price targets raised by a median of 3%.
  • Forecasting Brent crude to hit $90 a barrel due to demand and OPEC+ cuts, indicating strong future performance for the sector.

Energy Sector's Bullish Turn

Morgan Stanley has significantly shifted its stance on the energy sector, upgrading it to overweight due to what it describes as a "compelling valuation." This move comes after a period of underperformance relative to the broader market since September. The firm's analysts, led by Michael Wilson, project that the market rally will expand and pivot towards energy stocks, provided these companies can sustain earnings growth. This optimism is rooted in a late-cycle market environment that historically favors energy sector outperformance. Morgan Stanley's top stock picks within this sector include ConocoPhillips, Devon Energy, Occidental Petroleum, and Diamondback Energy.

Earnings Growth and Market Valuation

Despite being the top performer over the past month, the energy sector has lagged behind the broader market rally that began in October. However, Wilson points out that energy stocks have contributed more to the change in S&P earnings since the pandemic than any other sector. Yet, it remains one of the cheapest and most under-owned market segments. With the S&P 500 energy sector up more than 11% in 2024, and West Texas Intermediate futures gaining 14%, there's a strong indication of potential earnings growth. This is especially likely as the gap between stock performance and crude oil prices narrows.

Financial Health and Future Prospects

The energy sector's free cash flow margins have decreased over the past two quarters but are still above the historical average. Moreover, the sector's net debt compared to earnings before interest, taxes, depreciation, and amortization (EBITDA) is lower than the historical average dating back to 2010. These indicators of financial health, combined with the sector's attractive valuation and potential for earnings growth, suggest a robust comeback is on the horizon for energy stocks, according to Morgan Stanley's analysis.

European Energy Sector Outlook

Morgan Stanley's optimism extends to the European energy sector, with upgrades for Norwegian Equinor and Spanish Repsol, the latter being highlighted as a top pick. The firm notes that oil markets have been tighter than anticipated, and despite a significant drop in gas prices, they have reverted to pre-Ukraine war/pre-Covid averages. Adjustments to recent interest rate hikes and inflation forecasts have made current stock prices more appealing, signaling a positive outlook for the European energy sector as well.

Street Views

  • Devin McDermott, Morgan Stanley (Bullish on the energy sector):

    "An improving macro backdrop has started a catch-up trade for Energy... The sector is outperforming the broader market with energy up 12.5% year to date while the S&P 500 is up 10.1%... Energy is also comparatively cheap, trading two times lower than its historical valuation vs. the S&P 500."