Third quarter earnings season is just ahead, and it’s a cinch that markets are going to react when companies start reporting real results. The regular ritual of revealing actual performance versus the forecast guidelines gives investors the data they need to sort the grain from the chaff. The real trick is to interpret the results correctly.

That can depend on many factors, among the most important of which is volatility – and no market segment better shows that than the oil sector. Oil prices peaked five years ago, dropped sharply through 2015, and rose after early 2016. Crude prices gained steadily until Q3 of 2018, and then the bottom dropped out again. Since then, prices have failed to gain traction.

However, Jeff Grampp, writing from Northland Securities, sees increasing production as boding well for the third quarter. He writes, anticipating the earnings reports, “We expect the focus during earnings to continue to be on FCF and capital discipline. Sentiment seems likely shaping up to not fully reward good performance but certainly ready to punish underperformance, similar to last quarter. Also, while we do not expect many 2020 guidance releases, we are hopeful to get some high level commentary on strategic direction and balancing growth/FCF in the current environment.”

We’ve dipped into TipRanks’ Stock Screener to find three small-cap oil producers from just that region. A look at where they stand now, and what industry analysts are saying about them, may offer some insight into what the Q3 reports have in store.

Callon Petroleum (CPE)

Callon is a pure-play oil company – the company drills and sells only crude oil. The company has exploration and development rights for assets three counties stretching across the Delaware and Midland Basins of the West Texas Permian formation. It’s the heart of Texas’ most productive oil patch, and Callon is reaping the profits of it.

In Q2, the company reported 23 cents EPS compared to the forecast 18 cents, for a beat of 28%. The estimate for the coming quarterly report is, again, 18 cents per share. Callon has a small market cap of just $934 million, and the stock is priced at a low $4.09.

Northland’s Grampp says of Callon, “We expect much of the operational focus for CPE to be on success of its recent larger scale projects... We believe that the transaction should enable CPE to pursue an increased proportion of larger scale projects with a larger asset base. Recall, the company recently completed large scale projects in both the Delaware and Midland Basins.” Grampp gives CPE a $7 price target, suggesting a 71% upside potential.

Cowen analyst Gabriel Daoud is even more bullish on CPE. The analyst rates the stock an Outperform along with a $12 price target. Daoud’s target implies confidence, as it suggests a whopping high 193% upside potential.

Daoud noted, “Callon's attractive footprint across the Midland and Delaware Basin supports a deep inventory of high-IRR drilling opportunities, among the most economic across the L48, which should drive peer-leading margins, debt-adjusted production / CF growth, and multiple compression, all of which help frame our positive investment case. Operational missteps appear in the rearview as we believe successful infrastructure investment, less non-productive time, and increased familiarity with newer assets leaves the company well placed for improved execution moving forward…”

CPE’s Strong Buy analyst consensus is derived from 6 "buy" and 2 "hold" ratings. The stock’s low price offers investors a chance to ‘buy the dip’ on a high-upside opportunity. Shares are priced at $4.09, and the average target of $7.91 indicates potential for 93% growth.

Magnolia Oil & Gas (MGY)

Magnolia is a $2.65 billion oil company, based entirely on the Eagle Ford formation of South Texas. This rich petroleum producing area forms the eastern edge of the larger Permian Basin. Magnolia has assets in the Karnes County and Giddings Field regions, with room for up to 1,000 active wells.

Northland’s Grampp sees Magnolia hitting production figures of 70 million barrels per day, which would be in line with guidance. He says of the company’s expanding operations, “Other updates we hope to get are on smaller acquisitions, where the company has had strong success in expanding its Karnes County footprint. Additionally, we hope to get an update on its share buyback program as the company authorized a 10MM share buyback last quarter.”  A share buyback would be good for investors, as it would support the share price.

Grampp rates MGY stock an Outperform along with a $14 price target. With MGY trading at a low $10, Grampp's target makes this oil stock a fine choice for investors seeking an affordable point of entry.

Weighing in from Credit Suisse, analyst Betty Jiang takes a cautiously optimistic view of Magnolia. She met with the company’s VP of IR and the CFO in Toronto last week, and came away with a positive view of management’s plans going forward. Of Magnolia’s efforts to expand its drilling footprint and recoverable assets, she notes that the company plans to continue its strategy of purchasing smaller oil producers, and will pursue this strategy while prices remain low. She writes, “Management reiterated that their focus is on small, bolt-on opportunities in the Eagle Ford, funding it primarily through organic FCF.”

Looking at the actual production from current operations, Jiang was encouraged by management’s report of the numbers. She noted, “Management seems encouraged by early Giddings performance, repeatedly highlighting shallower decline profile of those wells (~50% first year decline) with peak production generally seen in month 2 or 3… Karnes well costs have already fallen from ~$5.5MM early in the year to ~$5.0MM currently and would likely remain fairly steady going forward.”

Given her basically positive view of the company, it’s no wonder that Jiang gives MGY a $13 price target, indicating a 28% upside potential.

Overall, MGY gets a Strong Buy on the analyst consensus. Wall Street analysts have given the stock 6 "buy" and only "1" hold ratings in the last three months. Shares sell for $10.19, and the $14.29 average price target suggests a healthy upside of 40%.

Matador Resources (MTDR)

Matador’s operations cover much of the Permian’s Eagle Ford formation. The company has active wells in southeastern New Mexico, West and South Texas, and in the northwestern corner of Louisiana. Oil operations pull in over $140 million per quarter, and the company guides on revenue of $540 to $560 million for FY 2019. Matador has beaten the earnings estimates in the last seven reported quarters. EPS grew steadily in the first half of this year, with the Q2 number, 30 cents, beating the forecast by 58%.

Grampp’s take on Matador is consonant with the company’s guidance and the conventional wisdom. He writes, “Our 3Q19 Adjusted EBITDA estimate of $146MM is about in-line with consensus of $145MM and our 3Q19 production estimate of 64.0 MBOEPD is within guidance of 63.1 to 64.3 MBOEPD but above consensus of 63.5 MBOEPD.” Grampp gives this stock a $22 target, implying room for a 63% upside.

RBC Capital analyst Scott Hanold made a detailed report on MTDR, including meeting with the company president and CFO. He came away impressed, and noted several points that bode well for Matador’s future. First, he points out that the company’s costs are coming down: “Drilling and completions costs dropped rapidly from over $1,500/foot in 2018 to ~$1,250/foot currently but there are more improvements coming.”

He then goes on to note that Matador has plenty of new drilling permits in process, and is set to maintain production on its drilling pads: “Permits for the Rodn  ey Robinson wells in the Antelope Ridge area were recently secured and two rigs are on location to complete the 6-well pad… The rigs then move to the State Line acreage, which we think is the most prolific portion of its portfolio. Permits for this acreage should come by YE19 and the wells should be online around September 2020.”

And finally, Hanold sees the company’s free cash flow improving going forward, as new wells come online and old assets are sold off, reducing the need for loans: “FCF neutrality for the upstream asset could take a couple years as MTDR builds scale toward 100 Mb/d but the outspend continues to narrow… Leverage is currently 2.5x and should stay below 3.0x. Several monetization opportunities are available including more Eagle Ford sales that could happen late this year or in 2020.”

Accordingly, Hanold rates MTDR stock an Outperform along with a $28 price target, suggesting an impressive 108% upside.

Overall, the word of the Street is an overwhelmingly bullish one for this oil stock, as TipRanks analytics exhibit MTDR as a Strong Buy. Out of 8 analysts polled by TipRanks in the last 3 months, 7 are bullish on the stock, while one remains sidelined. With a return potential of 77%, the stock’s consensus target price stands at $23.83.

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