These 2 Energy Stocks Are Ridiculously Cheap

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Most of the energy industry is still trying to shake off the prolonged slump from plunging oil prices. However, an elite group of oil and gas companies recovered from the market downturn more quickly than others because they had stronger balance sheets and prime positions in some of the lowest cost shale regions. Those factors have allowed them to grow at a fast pace and generate excess cash at much lower oil and gas prices than their peers.

Investors have flocked to this elite group and driven up their valuations. The top six sell for more than 11 times 2018 EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expenses), which is a common way to value exploration and production (E&P) companies. For perspective, the average E&P sells for around 7 times EBITDAX. But two energy companies trade below that average even though they have near elite-level metrics: Antero Resources (NYSE: AR) and Energen (NYSE: EGN). That ridiculously cheap valuation should grab the attention of value investors.

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Taking matters into its own hands

The six premium-valued E&Ps all share four elite qualities:

  1. They're large companies with enterprise values over $10 billion.
  2. All are growing briskly, with production growth rates currently above 15%.
  3. They have strong balance sheets with leverage ratios less than 2 times EBITDA.
  4. All expect to generate free cash flow this year.

That's worth noting, because natural gas producer Antero Resources currently boasts three of those four qualities. The only one it's missing is the leverage ratio, which it expects to hit next year. However, despite having near elite numbers, Antero trades at a ridiculously low 5 times EBITDAX.

The company is working to address the disconnect by hiring advisors to "[e]valuate various potential measures to address the discount in trading value of Antero's stock relative to some of the premier U.S. large capitalization upstream independents that have a similar profile in terms of leverage, capital efficiency, production growth, and free cash flow generation."

Among the options it's considering is returning some of its growing stream of free cash flow to investors, which could come through a dividend or buyback. It's a strategy that has helped fellow gas producing rival Cabot Oil & Gas (NYSE: COG) earn a premium valuation for its elite level metrics. In Cabot's case, it has significantly ramped up its cash returns to shareholders in the past year, boosting its dividend 150% in 2017 and another 20% in 2018 while also starting to buy back its stock. These dual fuels helped propel Cabot's shares up 13% in the past year even as Antero's have tumbled 30%. Antero hopes that by following in Cabot's footsteps, its valuation will take flight.

Same resource base for half the price

Permian Basin-focused producer Energen boasts several elite-level metrics. Its leverage ratio was below 1.3 at the end of last year, and production was on pace to be 34% higher. While the company is outspending cash flow to grow that fast, it could still increase output at a healthy pace if it chose to live within its means. Furthermore, while Energen's enterprise value is just $6 billion, its resource size rivals that of its larger, premium-priced peers.

For example, Energen noted that it currently controls more than 147,000 net acres in the two core regions of the Permian Basin and that it had more than 4,100 remaining locations that are economical to drill at $50 oil. For comparison's sake, red-hot rival Diamondback Energy (NASDAQ: FANG) has similar resources. While Diamondback holds 191,000 net acres, its economic locations at $50 oil are only slightly more than Energen at 4,300. Not only are the two resource bases quite similar, but Diamondback Energy also produced 85,000 barrels of oil equivalent per day (BOE/D) last quarter, which was just slightly more than Energen's 81,300 BOE/D rate. However, despite strikingly similar metrics and resources, Diamondback Energy's enterprise value is more than double Energen's at $13.7 billion.

That discount continues to infuriate its largest investor Corvex Management, which holds a 9.9% stake in the Permian driller. The activist hedge fund has been pushing the company to make changes because it trades "at what we believe is a material discount to its underlying value." They want Energen to take matters into its own hands and find a way to eliminate the valuation disconnect.

Bargains, for now

Antero Resources and Energen boast excellent resource bases and elite-level financial and growth metrics. While that should earn them premium valuations compared with other E&P's, both trade at a discount to their peers. That disconnect is driving Antero and Energen's top investor to seek out ways to get their valuations heading in the right direction. If they're successful, these bargains might not last much longer.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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