The energy sector is alight today after the oil price staged a decent rally in overnight trade to a near three-year high of US$65 a barrel.
This bodes well for oil stocks as they prepare to hand in their earnings report cards later this month, which could see a swath of earnings upgrades by brokers who have yet to fully account for the 40% odd rise in the price of crude oil over the last six months.
But don't only focus on sector heavyweights like Woodside Petroleum Limited (ASX: WPL), Oil Search Limited (ASX: OSH), Origin Energy Ltd (ASX: ORG) and Santos Ltd (ASX: STO). There are compelling buying opportunities at the smaller end of the market.
One such opportunity is Beach Energy Ltd (ASX: BPT), according to the analysts at Morgan Stanley. While the stock has jumped 4.4% in afternoon trade to $1.36, the broker thinks there is still a 25% upside to Beach Energy before the stock becomes fair value.
It's Beach Energy's cash generation ability that is getting Morgan Stanley excited, particularly after the company upgraded its production guidance while lowering its capital expenditure (capex) outlook to between $405 million and $455 million versus its previous estimate of $425 million to $535 million.
"Beach confirmed the Lattice assets generated $155 million of free cash during 1HFY18. This means free cash on a full year basis from Lattice could be $250 million to $300 million once further capex for Lattice is factored in," said Morgan Stanley.
"Including some addition from Cooper Basin means free cash from the entire Beach group should be $350 million to $400 million."
The broker has an "overweight" recommendation on Beach Energy and a price target of $1.70 a share.
Another oil stock to watch is FAR Ltd (ASX: FAR) as Credit Suisse predicts 2018 is a year of "reckoning" for the junior stock.
While FAR's December quarter production report was far from an exciting read, there is a lot happening in the background as the company and its joint-venture (JV) partners prepare to hand in the evaluation report for its Senegal project to the government of that country in May.
This will pave the way for the JV to submit its development plan and obtain final approval in November.
Achieving each of these milestones will trigger a re-rating in the stock, although Credit Suisse points out that FAR isn't a one-trick pony as FAR's Gambia A2 and A5 blocks, which are south of the Senegal field, will provide additional excitement for investors following the expected development of the flagship project.
"2018 is in many ways the year of reckoning for FAR and its JV partners, however you define them," said Credit Suisse, who has an "outperform" rating on the stock with a price target of 14 cents a share.
"By the end of 2018 it's possible government approval for a project with an initial plateau range of 75-125kb/d oil production and first oil in 2021-2023 has been cemented."
In other words, investors can expect a lot of news from FAR this year.
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