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How the Smart Money is Playing Oil M&A

Although WTI prices are still in the low $60’s per barrel, the sector has experienced a resurgence in M&A speculation thanks to Chevron’s first bid for Anadarko and Occidental’s later higher bid for Anadarko. While many analysts don’t believe Chevron will engage in a bidding war for Anadarko perhaps due to Warren Buffett’s $10 billion backing of the deal, many investors believe Chevron will consider other targets in the Permian Basin instead.

In this article, let’s analyze 4 oil stocks that some traders believe could be potential M&A targets and how the smart money is positioned among them. We track around 700-740 top funds in total.

Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the market by 32 percentage points since May 2014 through March 12, 2019 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

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Many traders believe Chevron Corporation (NYSE:CVX) might add to its Permian basin holdings. Given its attractive assets, Anadarko was a logical acquisition and many thought Chevron’s offer for Anadarko was a steal for Chevron in terms of Anadarko’s valuation. Unfortunately, Occidental made a higher offer and Chevron might not outbid it. Although it has the financial resources to win in a bidding war, Chevron CEO Michael Wirth has said before that he won’t overpay and Chevron will get a nice $1 billion breakup fee for its troubles. 48 top funds owned shares of Chevron Corporation (NYSE:CVX) at the end of the fourth quarter, down 8 funds from the previous quarter. Valuations are reasonable and Chevron could benefit from good M&A if oil prices go up.

In terms of which companies Chevron might potentially target, some traders think that Chevron could potentially target Pioneer Natural Resources Company (NYSE:PXD) or Concho Resources Inc. (NYSE:CXO). Concho operates in the Permian and has estimated proved reserves of 1.2 billion barrels of oil equivalent as of the end of December. Pioneer operates primarily in the Permian Basin too and has total estimated Permian proved reserves of 977 MMBOE. Both companies are mid-sized like Anadarko. 62 top funds owned shares of Pioneer Natural Resources Company (NYSE:PXD) at the end of December, up 4 funds from the previous quarter. Meanwhile, 35 elite funds had a bullish position in Concho Resources Inc. (NYSE:CXO) as of the most recent 13-F reporting period.

Diamondback Energy Inc (NASDAQ:FANG) has good assets in Wolfcamp, Clearfork, Spraberry, and more and has operations in the Permian Basin. The company also has good cash flow. Diamondback Energy recently announced that its board has expanded its capital return program, ‘with up to $2 billion of stock repurchases to be executed through the end of 2020’. Of the around 700-740 elite funds we track, 44 funds owned $2.13 billion of Diamondback Energy Inc (NASDAQ:FANG) on December 31, versus 37 funds and $1.33 billion respectively on September 30.

Although it is a smaller company than the other three companies mentioned before it, Matador Resources Co (NYSE:MTDR) is another potential target for M&A. Matador has attractive assets and its first quarter average daily oil equivalent production inched up 8% sequentially to 59,900 barrels of oil equivalent per day. In terms of outlook, management has made no adjustments to its full year 2019 natural gas or oil guidance.  Shares are up 26% year to date.

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