3 Undervalued Stocks in Oil Worth Buying

By Markets Fool.com

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Source: BP corporate website.

With the S&P 500 growing close to 90% over the past five years, it's getting harder and harder to find undervalued stocks in the market today. That is, unless you are looking in the oil and gas sector. The slog in oil prices that has gone on for close to a year now has presented several opportunities to buy undervalued stocks if you are willing to wait a while for the payback.

Of all the companies in energy today, three really stand out as undervalued: National Oilwell Varco , Atwood Oceanics , and Denbury Resources . Let's take a quick look at why these three companies are some of your best bets when looking at buying undervalued stocks in oil today.

The undervalued trio
There are lots of companies in the energy sector that boast some pretty low valuations in comparison to the broader S&P 500, but that shouldn't come as a big surprise, because the energy sector as a whole has always traded at a discount to the broader market. Over the past 15 years, the sector has traded at a price to earnings ratio of 16.6 times, while the broader market has traded at an average price to earnings of 25 times during that same time period.

What makes these three companies unique, though, is that they have both bargain-bin pricing on the market today as well as histories of decent operational reputations:

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  • National Oilwell Varco is the name when it comes to oil and gas equipment manufacturing. More than 80% of the drilling equipment on floating offshore drill rigs comes from National Oilwell Varco. This dominant market share and a standardization program that ensures any customer that needs a replacement aftermarket part comes back to National Oilwell Varco provides for strong cash flows over the long haul.
  • Atwood Oceanics may not be one of the flashier names in the offshore rig business since it is a smaller operation, but it has one of the newer fleets of floating rigs that are capable of handling the jobs production companies are willing to pay a premium for. At the same time, though, it has kept a more modest balance sheet and didn't chase too much growth with debt, which has helped the company generate the best returns on capital employed in the offshore business.
  • Denbury Resources gets unduly lumped in with other American oil and gas producers. Unlike many of its peers that are chasing shale, Denbury's primary business is extracting oil from mature sources with an enhanced oil recovery method of injecting CO2 into the reservoir to repressure the reservoir and release some of the oil left behind after conventional production is done. This business takes a lot of planning and prudent capital management, and Denbury has proven it can do it effectively by generating more cash than its capital expenditures for the past two years running, something very few other independent oil and gas producers can claim.

Here is what all three of these companies' valuations look like based on total enterprise value to EBITDA, price to earnings, and price to book value.

Current Valuation Metrics
Company TEV / EBITDA Price / Earnings Price / Book Value
National Oilwell Varco 4.9x 9.8x 1.06x
Atwood Oceanics 5.2x 7.3x 0.77x
Denbury Resources 3.5x 4.2x 0.46x

Source: S&P Cap IQ.

These numbers look pretty cheap by themselves, but if you compare them to each company's 10-year historical valuation, they look like a steal.

10-Year Historical Average Valuation
Company TEV / EBITDA Price / Earnings Price / Book Value
National Oilwell Varco 10.3x 19.2x 1.98x
Atwood Oceanics 11.3x 31.2x 2.32x
Denbury Resources 9.1x 23.6x 2.40x

Source: S&P Cap IQ.

Are they cheap for a reason?
Having a cheap valuation does not always mean each company is a guaranteed winner; sometimes a company is cheap because there is a structural flaw, such as deteriorating sales or increased competition wiping out margins.

In the case of these three companies, you could say their Achilles' heel is that they are all more dependent on higher oil prices than many others in the space. Atwood generates 73% of its revenue from its fleet of high-specification rigs for ultra-deepwater drilling, a majority of National Oilwell Varco's revenue come from the manufacturing of drilling packages for offshore rigs and the aftermarket replacement parts, and Denbury Resources' enhanced oil recovery process involves lots of up-front capital to inject CO2 into older oil fields.

As oil prices plummet, these more expensive types of oil are some of the first to see declining activity. Also, to add insult to injury for Atwood and National Oilwell Varco, there are way too many rigs on the ocean than what current demand requires. A lot of this has to do with the fact that there are several very old rigs on the water that need to be replaced, but many companies are hesitant to let go of them until their contracts are up.

Until this glut of rigs is cleared and oil prices are back on the uptick, these companies' profits are likely to suffer.

What a Fool believes
The silver lining in all of this is that oil prices are a fickle thing, and the scaling back of exploration and production spending today will come back to bite someday down the road, which will in turn mean oil prices will increase, and drilling activity will increase. That's just how cyclical commodities work, and investors who can see beyond the waves of the commodity market and focus on the horizon can see opportunity in times like today.

If Atwood Oceanics, National Oilwell Varco, and Denbury Resources can ride out this rough patch in the oil market -- the financials at each of these companies seem to suggest they are all capable of doing so -- then buying shares at today's prices could be a coup for your portfolio several years down the road.

The article 3 Undervalued Stocks in Oil Worth Buying originally appeared on Fool.com.

Tyler Crowe owns shares of National Oilwell Varco.You can follow him at Fool.com under the handle TMFDirtyBird, onGoogle+,or on Twitter@TylerCroweFool. The Motley Fool recommends Atwood Oceanics and National Oilwell Varco. The Motley Fool owns shares of Atwood Oceanics, Denbury Resources, and National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.