Crude oil prices are in a tailspin amid signs of weakening growth in China, a global supply glut and a downturn in investor sentiment towards the broader commodity market. The fall in crude oil-related stocks has been pronounced in Australia given the large weighting of oil and gas stocks in the S&P/ASX 200 Index (ASX: XJO).
Naturally, the downturn has led to sharp share price declines in the majors — Santos Ltd (ASX: STO), Origin Energy Ltd (ASX: ORG) and Woodside Petroleum Limited (ASX: WPL) — making any of them ripe for the picking. However, an investor looking for stability in the sector should consider Oil Search Limited (ASX: OSH), which, in my opinion, is the best growth pick within the oil and gas sector.
No longer a minnow
Oil Search started life as a junior oil and gas explorer before discovering oil in Papua New Guinea (PNG) in 1929. It has since become the largest investor and oil producer in PNG through annual production of approximately 28 million barrels of oil equivalent (mmboe) from the region. The scale of its operations has made Oil Search the third largest oil and gas producer in Australia, behind Santos and Woodside (meaning it's no small fish!).
Quality assets
The differentiating factor between Oil Search and the other majors is the quality of its assets; unlike Woodside and Santos, which mainly produce crude oil, Oil Search's primary product is liquefied natural gas (LNG). The company owns a 29% interest in PNG LNG — the world's largest LNG plant. The PNG LNG trains are in full production, earning substantial free cash flows (FCF) for Oil Search at current LNG prices.
Although LNG is part of the broader oil and gas market and thus linked to the oil price, the actual LNG price is determined by demand for natural gas. Spot LNG prices have slumped with the drop in crude oil despite demand for natural gas forecast to outstrip supply next year. Accordingly, Oil Search's share price decline appears to be caused by the market's misconception that any oil-related exposure will crimp profits. However, in my opinion, this perception has given rise to mispricing of Oil Search's shares, making it a strong contender for a re-rating when it reports later in August.
Stable profits
In its second-half production report, Oil Search increased production by 7% and sales by 5%, indicating robust results this financial year. Despite the downturn in oil prices, Oil Search is expected to increase its dividend payout by 300% due to its ample FCFs, taking its annual dividend to a forecast 80 cents per share. This places it on a forward yield of 11.4% at current prices.
Foolish takeaway
Whilst Oil Search remains captive to the underlying price of crude oil, the quality of assets it controls remains its biggest strength. Without being able to predict the bottom for its share price, I believe an investment in Oil Search today provides a cheap, high quality growth stock that should outperform the broader market when the downturn ends. In the meantime, Oil Search rewards investors with a fat dividend yield that should be supported by stable FCFs from its current projects. This makes Oil Search, in my opinion, a top growth pick at current prices.
