Despite a recent sell-off in the oil and gas sector, a Morgan Stanley analyst cites “consistent spending execution” and heavy use of excess cash flow “toward returns on capital and debt reduction” as reasons for remain supportive.

Overview of the oil and gas industry: Devin McDermott has an interesting take on both exploration and production and the integrated petroleum industries.

The E&P industry generated its highest quarterly free cash flow in over a decade last quarter; however, the group’s shares have fallen 12% since early July, the analyst said in a note on Monday.

The sector has also lagged around 25% behind oil commodity prices since 2020, indicating growth potential above 50% since the start of the year, he said.

As the second quarter earnings season approaches, investors should keep an eye on cost inflation, discipline in capital use, strategic moves and maximizing shareholder returns in the oil industry. and gas, the Morgan Stanley analyst said.

In anticipation of the second quarter results, McDermott provided his opinion on the industry and came up with five choices: Apache Corp. (NASDAQ: APA); ConocoPhillips (NYSE: COP); Chevron Corp. (NYSE: CVX); EOG Resources, Inc. (NYSE: EOG); and Occidental Petroleum Corp. (NYSE: OXY).

Apache takeaways: The recent inflation in input costs did not materialize on the company’s bottom line, mainly due to the global diversification of Apache’s platforms, McDermott said.

Apache recently announced four new oil discoveries off the coast of Suriname, and its partner JV TotalEnergies SE (OTC: TTFNF) began drilling at two additional sites in the first quarter, the analyst said. The results of the assessment at these sites have not yet been announced, although McDermott expects Apache to provide an update during its second quarter call, leading it to increase its EBITDA and its results. cash flow per share estimates of 18% and 12% above consensus, respectively.

McDermott remains overweight Apache, with a target price maintained at $ 33. The company is expected to report earnings after the market closes on August 2.

ConocoPhillips takeaways: As with Apache, its global E&P counterpart, regional diversification has kept input cost inflation from affecting ConocoPhillips results, the analyst said.

The company reduced its 2021 spend by around 4% due to improved synergies, indicating discipline in its use of cash, McDermott said.

With this in mind, ConocoPhillips is poised to become the leader in the E&P industry in terms of FCF generation potential and cash return, further supported by a strong management team and its high quality, low cost portfolio, a he declared.

ConocoPhillips shares offer a “quality for sale,” McDermott said. The analyst expects second quarter CPFS and EPS to be 8% and 14% above consensus, respectively.

McDermott remains overweight ConocoPhillips with a price target maintained at $ 85. The company is expected to release its results before the market opens on August 3.

Chevron takeaways: Chevron previously described four financial priorities, McDermott said: maintaining and increasing its dividend; fund its capital program; maintain a strong balance sheet; and return excess cash to shareholders.

Now that Chevron has achieved its first three goals, there is modest share buyback potential, the analyst said.

McDermott remains overweight Chevron, with a target price maintained at $ 149. The company is expected to publish its results before the market opens on July 30.

EOG takeaways: Recent spending discipline and high commodity prices should continue to support a strong balance sheet and higher returns on capital, McDermott said.

Management has indicated an allocation of capital to acquisitions that could further strengthen the FCF. A strong second-quarter FCF has the potential for a further dividend increase, following the $ 600 million dividend in the first quarter, the analyst said. Considering the company’s divestiture to China, that dividend could range from $ 600 million to $ 700 million, the analyst said.

Importantly, asset sales in China position the company with a greater concentration of exposure to North America, potentially allowing cost inflation to affect the company in the future, a warned the analyst.

McDermott remains on par on EOG with a price target maintained at $ 93. The company is expected to release its results after the market closes on August 4.

Western takeaways: Occidental is targeting $ 2 billion in asset sales for 2021, a development in line with the entire E&P industry, McDermott said. The company achieved $ 1.3 billion in revenue and made offers to achieve the rest, helping the company meet its debt reduction goal, the analyst said.

Longer term, Occidental aims to focus on carbon capture and sequestration, McDermott said.

The company’s Low Carbon Ventures (OCLV) unit “is developing multiple potentially transformative solutions to decarbonize,” according to the analyst’s note. OLVC has entered into several agreements, including the creation of “the world’s largest direct air capture facility” and a sequestration agreement in Texas, the analyst said.

This line of business is expected to benefit the company over the next two decades as the world seeks to reduce carbon emissions.

McDermott remains overweight Occidental, with a target price maintained at $ 40. The company is expected to release its results after the market closes on August 3.