Energy stocks tend to be superstars after a recession, rebounding sharply as the economy recovers. And this time around, the biggest winners may be midsize stocks most people have never even heard of, like Consol Energy or Pride International. Sure, Big Oil looks cheap, with firms like Chevron trading below the markets average price/earnings ratio and paying dividends upwards of 3 percent. But many midsize firms are growing faster than the giants, which helps explain why Exxon Mobil is willing to spend $30 billion in stock for shale-gas producer XTO Energy. These midsize players stock may offer more potential to pop than the big boys. Were far more optimistic on the midcap names, says Ted Harper, comanager of the Frost Dividend Value Equity fund and a veteran energy analyst.
With oil rebounding to about $80 a barrel at the start of 2010, the big producers have been gushing profits, which could flow to other firms in the industry. Worldwide rig counts have stabilized around 2,530, down 25 percent from 2008, leaving plenty of upside for a production rebound. While some major producers have trimmed their capital budgets for 2010, independent companies are planning to hike their budgets by an average of 12 percent, to $41.6 billion this year. The upshot? Rising revenue and pricing power for energy services and gear firms. The industry should see a good uptick in drilling activity in 2010, says William Herbert, cohead of research for Simmons & Co., an investment bank specializing in energy stocks.
Energy stocks could still falter, of course, for a variety of reasons. Natural gas prices havent fully bounced back with the economy, and the new shale fields are yielding heroic amounts of natural gas, says Herbert, which could result in a glut for years. A double-dip recession in the U.S. or slowdown in China could also whack oil prices. And crude has gotten a big lift from the dollars slide, which may not last either. You could say oil is about $20 to $25 a barrel higher simply [because] its priced in dollars and theres a weak dollar, Exxon Mobil CEO Rex Tillerson told an energy roundtable in the fall. Still, many analysts expect a gradual rise in energy prices, particularly if a global recovery takes hold. To find our picks among the lesser-known players, we looked for companies with a competitive edge, trading at reasonable prices relative to their growth prospects.
Petrohawk Energy La Salle County, Texas, is among the poorest places in the country, a sparsely populated patch of rolling hills with an abundance of scrub brush and grasses. But the region does have one thing going for it: 19 trillion cubic feet of natural gas in the Eagle Ford shale, a rock formation around 11,000 feet below the surface. Petrohawk (HK: 25.77, -0.59, -2.23%) announced the first major discovery in Eagle Ford in 2008 and has drilled 20 wells therewith 50 to 60 more planned for this year. The geology of the formation makes for relatively easy drilling, with costs as low as $5 million per well, half that of other shale fields. And companies in Eagle Ford can break even with gas prices at just $3.88 per million British thermal units, compared to $5 in other areas. The economics are very compelling down there, says Petrohawk CEO Floyd Wilson.
That could be a big advantage for Petrohawk. The firm specializes in horizontal shale drillinga technique thats opening up vast deposits of natural gas. Petrohawk expanded production by about 75 percent in 2009 and plans another 43 percent increase this year. Its costs are about 20 percent below the industry average, and it has built a reputation for smart land acquisitions, enabling it to profit even with gas prices near rock-bottom lows. Its all about location, says Manuj Nikhanj, an analyst with the Ross Smith Energy Group, an industry research firm in Calgary, Canada. They picked their areas very well.
Even with the economy recovering, gas prices may not bounce back to their highs. Inventories were recently at their highest level since 1994, according to the U.S. Energy Department, and the glut may only grow with rising imports of liquefied natural gas and supplies from the new U.S. shale plays. Several coal-fired power plants are coming on line over the next few years and could curtail gas demandwhere much of the increase in gas usage has occurred, says Jen Snyder, an industry analyst with Wood Mackenzie, an energy-research firm. And without a big jump in industrial or consumer demand, Wall Streets 2010 earnings estimates for gas stocks could prove too optimistic.
None of this has been lost on Wilson, who says Petrohawk has battened down the hatches to gird for a gas glut. The company plans to sell more than $1 billion in noncore assets, partly to pay down debt, and Wilson says the firm will have plenty of money to execute its expansion plans. The company has also hedged much of its 2010 production at prices above todays levels, allowing it to profit even if natural gas prices fall. Longer term, the stock has room to rise based on its cash flow and growth rate, says Dan Rice, manager of the BlackRock Energy and Resources Trust fund, which owns the stock.
Consol Energy In the Great Depression, Consol Energy (CNX: 52.90, -0.92, -1.70%) teetered on the brink of receivership before a restructuring helped it end the 1930s on more solid footing. The Baltimore-based coal-mining company fared much better during the Great Recession. Consols low production costs allowed it to remain solidly profitable even as the downturn sapped demand for its main product. Some analysts say Consolthe largest coal producer east of the Mississippiis poised to do even better in the years ahead.
Consol is in a good position to benefit from economic recovery, with some of the oomph coming from customers in coal-hungry countries like China and India. Consol, based in Canonsburg, Pa., sends about 10 percent of its production abroad and recently exported 250,000 tons of metallurgical coal to Chinathe first such shipment in 30 years. It also owns a terminal in the port of Baltimore, a relatively short trip from its mines in places like West Virginia and Pennsylvania. And supply isnt a problem: The companys coal reserves of 4.5 billion tons are enough to last nearly seven decades at recent production rates. In the near term, coal-mining companies still face slow domestic demand as utilities sit on large stockpiles of coal amid sluggish electricity production. Jefferies metals and mining analyst Michael Dudas says it helps that Consol already has coal contracts signed at higher prices for 2010, plus a disciplined management thats been willing to cut production when demand falters.
As the company waits for a rebound in its coal business, Consol CEO Brett Harvey tells SmartMoney that much of the companys growth will come from its 81.5 percent stake in CNX Gas, which gives it exposure to the Marcellus Shale, a promising natural gas reserve that stretches across several Appalachian mountain states. CNX also is one of the regions lower-cost producers. Harvey says Consol might also start to make some acquisitions in coal or natural gas. We have kept our powder dry as we work our way through this thing, he says.
FMC Technologies FMC (FTI: 58.80, +0.71, +1.22%) started out in the 1880s making spray pumps for orchards; in 2008, it finally spun off its agricultural-equipment business to focus on the faster-growing offshore oil industry. Today its the dominant maker of subsea treescomplex networks of valves used to control the flow of oil and gas from ocean basins to rigs, pipelines and ships. FMC has been setting world depth records for trees since the early 1980s and recently hit a record of 9,356 feet for a project in the Gulf of Mexico. And the business has been growing 31 percent a year, on average, since 2004. FMC CEO Peter Kinnear says he expects double-digit growth rates to continue in the coming years.
FMCs backlog of orders has been flat lately, at around $3 billion. But the company expects orders to pick up in 2010 and has identified more than a dozen projects during the next 15 months that could each bring in over $150 million in revenue. Its also capitalizing on a trend to move more production from offshore platforms to the seabed, says Robert MacKenzie, head of energy research at FBR Capital Markets. FMC has a fast-growing business selling systems to separate sand, gas and fluids on the ocean floor, which is more economical than separating them on a surface platform. The company also makes pumping and boosting systems that allow producers to extend an oil fields lifespan.
While FMC has 37 percent of the tree market, it faces fierce competition from Cameron International, which has been gaining market share. Profit margins could weaken as FMC runs through orders signed at peak prices and starts booking revenue for projects signed at lower prices in 2009. Indeed, analysts expect earnings to fall 12 percent this year before rebounding in 2011. Still, given next years expected profit growth, the stock looks reasonably priced, says Greg Herr, an analyst with the FPA Perennial fund, which owns FMC shares.
Pride International Offshore drillers went from boom to bust when crude prices collapsed in 2008 and early 2009, leaving hundreds of rigs idle. But demand for deepwater drilling has stayed strong, and oil-exploration companies plan to spend $162 billion through 2013 on such projects, up 36 percent from the previous five years, according to the energy-research firm Douglas-Westwood. All that bodes well for Pride International, an offshore driller remaking itself into a major deepwater player.
Already one of the worlds largest drillers with a fleet of 21 rigs, Pride is spending $3 billion for four new ships that can drill wells up to 30,000 feet below the ocean floorthe new deepwater frontier. Three of those ships are booked for five years, at rates averaging more than $500,000 a day. And with its new fleet, Pride will be more dependent on deepwater projects than any other U.S. driller, booking 60 percent of revenue this year in the segment. Once these ships come to market, theyll bump earnings significantly, says portfolio manager Stephen Davis, of the Alpine funds, which owns shares.
Investors in Pride (PDE: 32.78, -0.22, -0.66%) dont have to worry about near-term fluctuations in crude prices either. The firm has a $7 billion contract backlog, worth about six years of revenue for its fleet, while No. 1 offshore driller, Transocean, has a backlog worth only about three years. And Pride is on track to increase cash flow per share by an average 23 percent a year through 2012, says Bernstein Research analyst Scott Gruber.
Pride faces its challenges. The company spun off most of its slow-growing shallow-water-rig business last August, but its still exposed to that market, where theres spare capacity and pricing has been weak. Prides profit margins have been below average for much of the past decade, stemming partly from an acquisition spree in the 1990s that left it with a heavy debt load and high expenses. Still, Pride has cleaned up its balance sheet and now has a debt level of just 6 percent of total capital, one of the lowest in the industry. Wall Street expects profits to drop about this year but forecasted earnings will soar in 2011. Trading at about 16 times this years earnings, the stock isnt cheap. But Rikard Ekstrand, comanager of FPA Capital fund, says the premium looks warranted because Pride is still selling below the value of its assets and is building value every year.
Plains All American Pipeline Given the wild swings in oil prices, few would mistake energy for a predictable industry. But one corner of the business provides a semblance of stabilitypipeline operators structured as master limited partnerships, or MLPs. Partnerships like Plains All American Pipeline (PAA: 54.87, +1.36, +2.54%) typically make money through long-term contracts based on how much oil or gas they move, not its cost. They are effectively a tollbooth operator, says James Shelton, chief investment officer at advisory firm Kanaly Trust, which holds Plains in some client accounts.
MLPs must pay out the bulk of their profits through distributionstheir version of dividends. That means income-hungry investors can grab attractive yields, about 7 percent in the case of Plains. Although MLPs require additional paperwork at tax time, they come with an attractive perk: Investors dont pay taxes on about 80 percent of the income until they sell. Higher payouts, however, require the MLP to grow, and that typically requires financing for big-ticket projects. Their dependence on the credit markets pummeled MLPs during the financial crisis. But Plains, which boasts an investment-grade credit rating, raised about $1.8 billion in 2009. That positions Plains to build on its strong record of savvy projects and opportunistic acquisitions as other partnerships struggle, says John Cusick, MLP analyst at Oppenheimer.
Plains isnt immune to the downturn, as lower energy use weighs on profits. Company executives forecast 2010 profits of $475 million to $580 million, indicating a potential decline from the $520 million to $549 million that the Houston-based partnership is expected to report for 2009. On the plus side, Plains has boosted its quarterly payouts in eight out of the past 10 quarters. Analysts expect that to continue, in part because Plains has built up a cushion to ensure that payouts are sustainable. Its a nice place to sit and generate cash until you figure out what the economy does, says Steve Stahler, a Louisiana-based financial planner who has been buying MLPs for clients.
Read more: The Best Bets in the Oil Patch (Page all of 3) at SmartMoney.com http://www.smartmoney.com/Investing/Stocks/The-Best-Bets-in-the-Oil-Patch/?page=all#ixzz0d1oiRL9O
AZZ Price at posting:
67.0¢ Sentiment: Buy Disclosure: Held
