The best time for value investors to buy cheap is when stocks are down. The price of oil has recently dropped by a few dollars per barrel as investors have become more concerned about global growth. Signs of a soft patch in the U.S. economy have appeared, much of Europe remains in a recession (if not worse), and China is also seeing slower growth. This has caused many commodities like copper, iron ore and oil to decline. However, we have seen these concerns before in the past couple of years, and it was never too long before oil spiked higher for one reason or another.
A number of factors could cause oil to move higher in the short-term and that includes tensions in the Middle East, and the Summer driving season which will be upon us soon. It also makes sense to buy oil sector stocks on dips for the long-term potential because as consumers in emerging market countries increase their energy usage and buy cars, the demand for oil is likely to climb higher. Below, I have focused on a couple of cheap stocks that trade below $7. This is because low-priced stocks tend to have more volatility than a company like Exxon Mobil (NYSE:XOM) would. These stocks also tend to be under-followed and therefore are more often undervalued when compared to large cap stocks. It also makes sense to focus on stocks that appear to have very favorable risk to reward ratios. The picks below fit this profile as analysts expect these stocks to double in value. Here are the two stocks that appear cheap after a recent pullback, and could also be poised to double:
Warren Resources, Inc. (NASDAQ:WRES) is an independent oil and gas company with reserves and production in Wyoming, California, Texas, North Dakota, and New Mexico. It is also a leading developer of coalbed methane natural gas in the Rocky Mountain region. This stock has been in a trading range for the past several months of between $2.60 to about $3.35 per share. A recent bit of volatility in the stock market combined with a pullback in the price of oil has put pressure on many stocks in this sector. This has created a buying opportunity in Warren Resources and this stock appears very undervalued now.
While many oil stocks trade at a multiple of book value, this one trades just below book value, which is $2.69 per share. The company is expected to earn about 30 cents per share in 2013, which puts the price to earnings ratio at a very reasonable 8 times earnings. That is low when compared to many other small oil companies.
The company plans to increase the value of its existing asset base by developing projects that have high-potential for production and reserve growth. It has identified a total of approximately 150 additional gross oil well locations in the Wilmington Field for future drilling. It hedges a portion of its production which reduces risks for the company and investors. A hedge provides additional cash flow certainty and more consistent financial results. Warren Resources plans to drill 13 new oil wells and 3 water injection wells in the Wilmington Townlot Unit or "WTU" and in the adjacent North Wilmington Unit or "NWU", it plans to drill 4 new oil wells and 3 injection wells during 2013.
Most of its drilling locations are in proven areas that have provided predictable results. In California, it has identified 150 additional drill sites and in Wyoming it has identified 200 drill sites and 1,800 coalbed methane natural gas locations. It also maintains operational controls in about 92% of its producing wells. This reduces risks for the company and shareholders. The fact that this company is profitable also significantly reduces risks. Warren Resources has projects in the Washakie Basin in Carbon County, Wyoming, which is part of the Green River Formation. This is a potentially huge positive factor to consider because the Green River Formation is estimated to have around 750 billion barrels of recoverable oil. This could mean there is tremendous potential for this company to grow reserves and production.
Another potential sign of undervaluation is the fact that insiders own a significant stake in the company and there have been additional purchases of stock recently. On March 13, 2013, Arthur Epstein (an officer) purchased 10,000 shares. (Mr. Epstein now holds nearly 1.4 million shares). On the same day, Marcus Rowland (a director) purchased 10,000 shares.
On March 12, 2013, analysts at Sidoti initiated coverage of Warren Resources with a buy rating and set a $5 price target. Sidoti & Company LLC is focused on equity research on small capitalization companies. With the stock trading at about half that level now, the upside potential of a double makes this an investment worth considering while it is still trading at cheap levels.
Key Data Points For Warren Resources From Yahoo Finance:
Current Share Price: $2.52
52-Week Range: $2.08 to $3.41
2013 Earnings Estimate: 30 cents per share
2014 Earnings Estimate: 46 cents per share
Key Energy Services, Inc. (NYSE:KEG) is a leading provider of oilfield services to the energy industry. It offers rig services, rental equipment, drilling fluids, disposal of produced water, tubing services, fishing services, well testing, hydraulic choke services and more. It has about 8,500 employees worldwide and generates around $2 billion per year in annual revenues. While it has focused on North America, it also has operations in North and South America, Russia and the Middle East. There are a few reasons why this stock appears to be a bargain for longer-term investors to consider now.
Key Energy shares appear undervalued when looking at a number of factors. This stock is trading below book value which is $8.30 per share. While profits are expected to be only about 47 cents per share in 2013, analysts expect 80 cents per share in 2014. Revenues are also expected to jump roughly 10% from about $1.97 billion in 2013, to around $2.21 billion for 2014.
The "smart money" has been buying this stock. Mark H. Rachesky is a brilliant investor who founded and runs MHR Fund Management, LLC. This fund owns a sizeable stake of nearly 17.5 million Key Energy shares. This represents about 11.5% of the entire company and this holding has a market value of over $121 million. A number of other high-profile institutions and mutual funds also hold significant stakes in this company.
With interest rates at record low levels, many major corporations are looking to put cash to work through mergers & acquisitions. There have been a number of high profile deals in the energy sector and this trend is poised to continue. General Electric (NYSE:GE) recently agreed to buy Lufkin Industries (NASDAQ:LUFK) for about $3 billion. General Electric could be prepared to make additional takeovers in this sector and many other companies are also likely to consider deals this year. With a market capitalization of just about $1 billion, Key Energy could be an ideal takeover target for some of the major players in this industry. Companies like General Electric, oilfield services giants like Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB) all have the size and balance sheet strength to make an acquisition of a company like Key Energy.
Key Energy gave guidance for the first quarter which wasn't particularly optimistic, however, it is expecting better results for the rest of the year as the company stated:
"We forecast first quarter 2013 consolidated revenue to decline approximately 5% compared to the fourth quarter and project first quarter earnings of $0.02 to $0.04 per share as a result of cost inefficiencies associated with underutilized assets and labor in our U.S. Rig Services business."
Alario continued, "We believe U.S. activity will begin to recover in the second quarter, and expect activity for 2013 to approximate 2012 levels. We anticipate another good year in 2013 in our international segment following 67% revenue growth in 2012. The stalled activity growth in Mexico in the fourth quarter has already resumed, and assets delivered to Mexico and Colombia late in 2012 should fuel additional growth given a full year's contribution in 2013.
While a major recession or a prolonged and serious decline in the price of oil would create major downside risks for shares of Key Energy, those risks seem limited at this time. The recent decline in oil prices has been minimal and since Key Energy does not have direct exposure to the price of oil, that reduces risks for investors. Because of this, the recent downside pressure on the stock seems like an ideal buying opportunity. Just recently, analysts at MLV & Co gave Key Energy Services a buy rating and set a price target of $12. With the shares now trading around $6, this could lead to double for investors who buy now.
Key Data Points For Key Energy From Yahoo Finance:
Current Share Price: $6.50
52-Week Range: $5.70 to $14.26
2013 Earnings Estimate: 47 cents per share
2014 Earnings Estimate: 80 cents per share
Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WRES, KEG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.