Continue Reading Below
I took a very cautious stand on energy five months ago, sharing some names to avoid in the sector based upon my impression that they were both over-extended and expensive. At the time, energy for the S&P 500 was up 16.5% YTD, about twice as much as the overall market, and I was concerned that the sector had gotten ahead of itself.
Well, the pendulum has swung the other way. As of 10/3, the return for energy stocks in the S&P 500 is -15.5% compared to a 12.6% decline in the S&P 500. My focus today is on oil and gas stocks (thus, excluding coal, which has also been hit very hard). The price of oil has either fallen or increased this year, depending upon the benchmark you're checking. West Texas Intermediate (WTI) has declined from about $91 to $76 per barrel, but Brent (BNO) (perhaps a more important indicator) has increased slightly to about $100 from roughly $93 - a very strange divergence. In any event, both indicators are down sharply from their recent highs, as concerns about collapsing global demand have depressed the price.
With oil and gas stock prices coming down hard, as the overall tone of the market has been horrible, it seems to me that some prices have fallen so much that they should be able to stand up to further oil price declines. Given the precarious state of the economy and the markets, though, buying these names can be risky. With this in mind, I wanted to find some stocks with both low P/E and low valuation to their tangible book value (their hard assets less their liabilities) along with a balance sheet that is relatively strong. Taking these factors into account, I screened the oil & gas names of the S&P 500 (Large-Cap) and S&P 400 (Mid-Cap) for the following criteria:
· Forward P/E < 10
· Net Debt to Capital < 20%
· P/TB < 1.6
We started with 58 energy names. Here are the 12 that made this first cut:
Let me first start by saying that just because a stock made this list, it’s not necessarily a buy. Then again, just because a stock didn’t make this list doesn’t mean it’s not a buy! The screening process is just the beginning – you need to more thoroughly investigate any potential investment. Finally, be aware that the P/E ratios of the stocks above may be overstated, as analysts have most likely not yet fully incorporated the Q3 oil price declines.
The typical stock in this group is down 25% YTD, so substantially more than stocks in general or energy prices. I sorted the stocks on P/E, with the highest P/E at 8.2 and a typical P/E of 6.8. The typical stock is trading near the net value of its hard assets. I also included the dividend yield, which ranges from zero for a couple of drillers to as high as 4.3% for one of the integrated companies, ConocoPhillips (COP). I also included the 10-year annualized EPS growth rate – note that most of these companies measure their growth in double-digits.
In the last column, I included the stock's sub-industry. We have two pure refiners, four drillers, two E&P companies and four integrated companies (meaning E&P and refining/marketing).
I am not a big fan of the drillers, as they tend to be more volatile than the producers, but Helmerich & Payne (HP) deserves a call-out. In my opinion they're one of the most technologically advanced companies, offering a premium product. I like the idea of buying good companies when investors are selling indiscriminately.
I don’t follow Devon (DVN) and Apache (APA) that closely, but their valuations (especially APA's) look compelling. I continue to like Chevron (CVX), which hasn’t dropped very much but looks inexpensive on a P/E basis.
Finally, I am most interested in looking further into the two smaller integrated companies, Hess (HES) and Murphy Oil (MUR). Despite strong balance sheets, both companies' stock prices have both fallen sharply. Judging from the recent 10-Q, MUR had a setback in Indonesia. Like other refining industry players, they are divesting assets – in the UK in their case. HES has some Libyan exposure. Despite extensive refining/marketing operations, both companies make almost all of their profit on the E&P side. Neither of these companies traded this cheaply on either forward /PE or tangible book value in 2008-2009.
As I stated, I am more optimistic on the energy sector than I have been. I've liked the large integrated companies for the bulk of 2011 relative to the rest of the sector. They continue to appear attractive in terms of potential risk and opportunity, with some of the lesser known ones catching my attention (HES and MUR). The screen I shared is designed to identify companies with better valuation metrics and stronger balance sheets than other stocks in this sector.
Disclosure: Alan Brochstein is currently holding no positions in the securities mentioned in this post.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Alan Brochstein maintains a business relationship with TradeKing.