Seeking Alpha
Profile| Send Message|
( followers)  

By David Sterman

As the U.S. economy underwent a heady boom in the 1950s, our nation's energy needs grew at a rapid pace. Seizing an opening, legendary oilman T. Boone Pickens used his geology degree to become one of the energy industry's most aggressive wildcatters. (These are folks who seek oil gushers in fields not necessarily known to hold any oil wells.)

He eventually sought a less risky path, founding in 1959 what later became Mesa Petroleum. Mesa bought or leased land that had proven oil reserves, delivering steady gains to his investors in the 1960s and 1970s.

By the early 1980s, Pickens changed tack again: His Mesa Petroleum pulled off a series of acquisitions of much larger firms, helping to create one of the nation's largest independent energy producers. Instead of buying undervalued real estate and searching for oil, he sought undervalued companies that were already active drillers.

Fast forward to today, and Pickens' approach has changed yet again. In recent years, his investment firm, BP Capital, has been content to buy and sell large chunks of other companies for his investment fund, without dealing with the messy actions of buyouts and mergers.

One thing has remained constant: Pickens likes to buy low and sell high. And of the numerous stock purchases that his BP Capital has made in recent months, two stand out as especially-deep value plays.

1. Marathon Oil
Pickens' BP Capital established an initial 185,000-share position in Marathon Oil (NYSE: MRO) in the fourth quarter of 2012 at an average price of $30.44.

Though the stock had already been on the rise when he bought at about $30.40, it's rallied further. Judging by the still-cheap valuation for Marathon Oil, Pickens may be able to secure 30% or 40% more upside in the stock's value.

(click to enlarge)

Roughly a year ago, I wrote about this company, and though Marathon would go through unexpected developmental pains in 2012, the investment case in that article stands. Marathon possesses a strong base of real estate in the U.S. and elsewhere, and management shows a stronger hand when reining in costs and boosting cash flow.

In 2012, Marathon management learned that the company's plans to pursue a wide range of drilling activities -- from the Eagle Ford shale in Texas to the oil sands of Canada to operations spanning the Middle East and Africa -- was not fully appreciated or understood by investors.

As a result, several assets may be sold this year, including a 20% stake in the Athabasca Oil Sands project. According to research firm Wood Mackenzie, that stake is worth roughly $7 billion. "Assuming a transaction is completed, MRO plans to allocate the proceeds to share repurchases, accelerate development of the Eagle Ford shale, and modest debt reductions," note analysts at global financial services firm UBS.

Analysts at Merrill Lynch suggest the company's global drilling strategy will still have many moving parts -- even after any asset sales -- but investors have recently grown to accept that current drilling projects will still pay off handsomely, which explains the recent rebound in the stock. "Execution of MRO's unconventional development program in the lower 48 states is slowly gaining recognition by the Street," write analysts at Merrill Lynch, who have a Street-high $45 price target.

For a number of analysts who follow the company, all eyes are on Marathon's massive acreage in the Eagle Ford shale region. (Note that rival EOG Resources (NYSE: EOG) has been one of the hottest stocks in the exploration and production sector, thanks to its highly-productive wells in that region.) Marathon's approach to the Eagle Ford region is a bit less sexy: "MRO recognizes the outstanding economics of individual Eagle Ford wells, but it takes a big picture perspective in the development plans," note analysts at Morgan Stanley. In effect, Marathon is slowing spending to extend the shelf life of the shale play for years to come.

[See also: "The Latest Major Energy Discovery Could "Dwarf North Dakota"]

Fadel Gheit, the well-regarded oil industry analyst at Oppenheimer, recently raised his price target on Marathon Oil from $40 to $45, noting that the company is one of the few major natural gas-focused drillers likely to generate robust free cash flow in coming years. He sees free cash flow hitting $900 million this year and $1.5 billion in 2014.

2. Occidental Petroleum
Just as Marathon's nascent push into shale gas regions was initially poorly received by investors, Occidental Petroleum (NYSE: OXY) also recently fell out of favor.

Goldman Sachs' analysts note that 2012 was "one of Oxy's more challenging years, arguably since the 1990s." They note that a ramp-up in shale drilling and profits lagged forecasts throughout the year. Goldman has a $95 price target on the stock.

Yet there's a wildcard in play, which may be the reason why Pickens decided to establish a 63,000-share position (at an average price of $78 a share). The company known as Oxy Pete is sitting on massive Californian acreage. And signs are emerging that the Golden State may become the next major new shale region as regulations coalesce to support fracking (the deep-earth extraction of energy sources) in that state.

(click to enlarge)

[See also: "2 Top Ways to Profit from American Energy Independence"]

Analysts at UBS, who have a $97 price target, note that despite its recent weak quarterly results, Oxy Pete remains a prodigious cash flow producer. And that's fueling rising share buybacks and dividend hikes. The dividend stood at $2.08 in 2012, but should rise to $3.30 a share by 2015, according to Goldman Sachs.

Risks to Consider: Pickens' energy picks are dependent on energy prices, and these two companies have made an increasingly aggressive shift toward natural gas in recent years.

Action to Take --> Pickens' approach is simple. Marathon Oil and Occidental Petroleum possess a strong base of global drilling acreage, have been making increasing investments in U.S. shale gas plays, generate solid cash flow, and are trading at valuations slightly below the peer group. Pickens clearly prefers these over smaller, more speculative drillers.

Source: Why T. Boone Pickens Loves These 2 Energy Stocks