By Ahmed Ishtiaq
Energy stocks have been depressed for some time now due to the slowdown in the global economy and weak commodity prices. In addition, some energy giants have faced troubles of their own. British Petroleum (NYSE:BP) suffered heavily due to the oil spill in the Gulf of Mexico. Despite strong operational results, BP lost almost half of its value due to the incident. Further, the discovery of Shale plays increased the supply of natural gas in the U.S. and brought down giants such as Chesapeake energy (NYSE:CHK). As a result of these events, some of the biggest players in the energy sector are trading at a discount. In this article, we have tried to identify energy giants, which offer deep value. All of these players have bright long-term futures. However, at present, they are trading at a significant discount.
Chesapeake Energy :
The second biggest natural gas producer suffered heavily due to the sharp decline in the natural gas prices. In 2005, natural gas hit its all time high, and the natural gas futures traded above $14. Most of the companies shifted their focus to the natural gas segment and started buying gas rich assets. For some time, the strategy worked, and the participants achieved significant growth. However, due to oversupply and less cold winter, the demand for natural gas came down and prices fell to historical lows. As a result of increased investment in the shale plays, the company has a significant amount of economically unviable assets on its books. At the moment, the company is writing down and selling most of its assets in order to pay down its debt.
The sale of assets should help the company improve its balance sheet. Investors became skeptical about the prospects of the company due to its reliance on natural gas and high levels of debt. However, if the company is able to tie up a deal to sell its remaining assets at the start of 2013; its stock price will start to go up. Chesapeake is shifting its fracking resources from gas to oil, which will decrease its exposure to risky natural gas segment. At the moment, the stock is under pressure due to the delay in asset sales and temporary increase in the debt. I believe this is a short-term pressure and the price of this energy giant will bounce back soon.
Formerly British Petroleum, BP suffered immensely due to oil spill in the Gulf of Mexico. The company is still in the process of paying damages and fighting the lawsuits. However, the company has already put aside funds to pay the claims. One of BP's biggest strengths is that it has extremely strong cash flows. In 2011, cash flows from operations stood over $22 billion, showing a massive improvement on the $13.6 billion at the end of 2010.
In a previous article, I analyzed free cash flows of the company over the past three years. Although the company has faced a lot of issues recently, the overall performance of BP has been impressive. The company has done well in the slow global economy and weak commodity prices. BP manages its assets with remarkable efficiency. Recently, the company sold its 50% share in TNK-BP to Rosneft, a Russian integrated oil and gas company. The deal will bring BP $17.1 billion in cash along with 12.84% shares of Rosneft. After the completion of the transaction, BP will hold 19.75% of Rosneft. In addition, the company is expanding its operations in Angola and the North Sea.
BP pays cash dividends of $2.16, which amounts to a dividend yield of 5.27% based on the price of $40.95. During the past year, the company paid cash dividends of $4.13 billion, whereas it had free cash flows of $4.3 billion. Recovering global economy and increased production should increase the cash flows for BP. As a result, the company may increase its dividends in the next year. Overall, BP looks an extremely attractive investment at current price levels.
ConocoPhillips is the world's biggest production and exploration company based on oil production and reserves. Over the past three years, the company has shown remarkable growth in its earnings. ConocoPhillips net income stood at $4.4 billion, which went up to $12.4 billion by the end of 2011. In addition, the company has extremely impressive cash flows. At the end of 2011, COP generated over $6 billion in free cash flows.
In the most recent quarter, the company generated $3.9 billion in cash from continuing operating activities, excluding working capital. Cash generated by continuing operating activities stood at $3.5 billion. The company also received $0.5 billion in proceeds from asset dispositions. COP funded a $3.7 billion capital program, paid dividends of $0.8 billion and reduced debt by $2.0 billion. In addition, ConocoPhillips has a dividend yield of 4.75%, and an annual dividend of $2.64. The company has a low payout ratio of 31%.
Debt to Equity
All of these companies are trading at a discount at present. In addition, these companies have strong margins and impressive P/B and P/S multiples. Only CHK has a debt to equity ratio of more than 1, which should come down as the company brings down its debt at the start of 2013.
The energy sector will remain under some pressure in the short term due to a decrease in demand. However, in the long run, all of these companies will do well. Current price levels provide an exceptional opportunity to add these stocks to one's portfolio. I believe the downward pressure on the prices of these stocks is temporary and prices will rebound soon.
A recovery in the global economy will increase demand over the next two years. As a result, these stocks will go up substantially. In addition to the capital gains, these stocks offer healthy dividends. I expect BP and COP to increase dividends as the cash flows from operations increase over the next year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.