2 Oil And Gas Buys, 3 Sells

by: Investment Underground

By Brett Bivens

Like most equity sectors, oil and gas stocks have been negatively affected by softening economic conditions, and the desire of many investors to move into more safe-haven investment vehicles. Oil and gas stocks generally move with the overall equity market as demand is driven largely by consumer confidence and spending. If the low interest rate environment in the United States buoys the equity markets in the near future, investors can expect to see strong gains from the oil and gas sector:

Exxon Mobile Corporation (NYSE:XOM)

XOM, which has dipped from a high of over $87 per share in early May, represents a relatively conservative play in an otherwise volatile market. With a conservative debt profile and a 2.57% dividend yield, XOM remains an attractive buy. The company has increased its dividend for 29 straight years and with a low free cash flow payout ratio, the potential for dividend growth remains.

Although the stock may not be cheap on a price-to-earnings basis relative to peers (9.50 times), it does feature a higher return on equity (25.65%) than competitors like BP Plc (NYSE:BP) and Chevron (NYSE:CVX), which return 20.82% and 21.38%, respectively. Investors that believe in the growth of global energy demand should take a long look at XOM.

Chesapeake Energy Corporation (NYSE:CHK)

Although CHK has experienced large swings in price in recent months, it remains up 19.61% in the past year. The company recently announced strong early results from new drilling operations in eastern Ohio and Western Philadelphia. The company pays a dividend of just over 1% and offers the potential for strong capital gains as it remains relatively inexpensive and the natural gas industry figures to play a large role in the future growth of the global economy.

There are a number of reasons for bullishness when it comes to the U.S. natural gas industry. For one, technological improvements have allowed companies to utilize more efficient drilling wells, aiding margins and profitability. Additionally, growing industrial demand and the continued shift from coal to natural gas will spur industry growth in the long term.

The company has indicated a capital shift into higher-margin liquid-rich drilling.

Quarter-over-quarter revenue growth and much higher year-over-year revenue growth than the industry average (64.9% vs 19.0%). These strong growth prospects make CHK a strong value play for investors looking for exposure to the natural gas sector.

GMX Resources Inc. (GMXR)

GMXR has experienced a strong downward trend and currently trades towards the low end of its 52-week range. Additionally, double-digit short interest indicates bearish sentiment towards the stock. Among 30 “micro cap” companies in the independent oil and gas industry, only two have higher short interest than GMXR’s 10.59%. Although the strong earnings growth and the anticipation of increased production are attractive, this stock is likely not a buy at this point. It is best to take a wait and see approach toward GMXR and take a position once it regains some confidence from the market.

ATP Oil & Gas Corporation (ATPG)

Another stock with high levels of short interest (43.86%), ATPG currently trades in the low end of its 52-week range and has experienced a strong downward trend since reaching highs at the beginning of March. With a forward price-to-earnings ratio of 6.19 times, the company is selling at a very inexpensive level relative to similar sized competitors. Goodrich Petroleum (GDP), for example, trades at 13.32 times forward price to earnings and Petroleum Development Corporation (PETD) trades at almost 30.00 times.

Despite this, high debt levels and uncertainty regarding earnings make this a speculative play if anything. With debt to equity of almost 14 times, ATPG is almost 4 times more levered than GDP (3.31 times). Moody’s expects that ATPG will need to restructure its debt in the near future as the company likely lacks the necessary assets and cash flow to cover its obligations. Management believes that expansion in the Gulf of Mexico will allow them cover their debt service, but based on the uncertainty, we recommend a wait-and-see approach as the company goes through this turnaround phase. If management is right, this is a triple, due to the company's robust production numbers before major debt liabilities come due in 2015.

Apache Corporation (NYSE:APA)

Like other companies on this list APA has been hit hard by equity market instability in recent months and has seen almost 40% of its market cap evaporate since hitting a high of $133.37 in late April. With strong revenue growth (quarter-over-quarter growth of 45.96%) and solid margins, the company represents a more attractive investment than many others in the sector. Despite the large drop in price, the company’s forward price-to-earnings ratio remains high relative to others in the industry but that doesn’t necessarily mean that the stock is overpriced.

The company recently announced plans its acquisition XOM’s Beryl Field, along with other assets in the UK’s North Sea. The acquisition will allow APA to grow its North Sea business significantly and is accretive to earnings, cash flow, and production.

With return on average capital employed of almost 12%, the company bests competitors like Devon Energy (NYSE:DVN) at approximately 11% and EnCana Corporation (NYSE:ECA) at around 9%. This metric, used to measure businesses in capital intensive industries, indicates how efficient a company is at converting employed capital to profitability and displays the management quality of APA. Another positive investment point is the company’s debt to cash flow, which at approximately 1.00 time is much lower than most of its direct competitors, based on Q1 2011 numbers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.