In recent weeks, oil and gas stocks have been looking to gain traction amid weak global economic projections and general bearish investor sentiment. Moves among stocks in this sector are highly correlated with the market and a low interest rate environment could potentially push investors to return to equities in search of higher upside. Here are four we think are sells, and one that's a buy at current levels:
Sandridge Energy Inc. (NYSE:SD)
SD, trading near its 52-week low, is a stock that many investors have shied away from during the recent market volatility as they look for more “risk off” trades. The company is very highly leveraged, at 2.58 times debt to equity, relative to competitors. For comparison’s sake, similar sized competitors like EV Energy Partners (NASDAQ:EVEP) and Whiting Petroleum (NYSE:WLL) both have leverage of under 0.6 times. With an unclear picture of where energy stocks are heading, it may be prudent to look to companies with lower leverage if one desires exposure to this sector.
In order for SD to compete in the long term, it will need to continue its high levels if revenue growth while maintaining margins in order to push earnings higher. The way for them to accomplish this may be further debt, pushing the risk in the investment higher. Although the company is well hedged, their stated goal of debt to EBITDA of under 2 times will prove difficult to achieve. We recommend a wait and see approach with SD so that we can properly gauge management’s progress in lowering its debt levels.
New Dimension Resources Ltd. (OTC:NWDMF)
Given the current state of the market, penny stocks likely offer too much risk for the average investor’s portfolio. New Dimension’s operations do not generate cash inflows, and the company’s continued existence depends on management’s ability to raise additional equity financing until it realizes success in exploration and development of its mineral properties, something that will prove difficult for a company like this in the current economy.
The company is well diversified geographically, with a sizable and growing presence in South America (primarily Peru) and may be a decent speculative play for investors looking to up the level of risk in their portfolios. Still, given the lack of profitability and return on equity of -71.12%, New Dimension is not a buy at this point.
Hercules Offshore, Inc. (NASDAQ:HERO)
Like many companies in the industry, HERO has seen its market capitalization diminish significantly in light of market instability in recent months. After a strong run-up in share price during the first half of 2011, momentum turned and the stock has been in a strong downtrend since. With a negative operating margin and an inability to keep pace with industry revenue growth, HERO doesn’t look like a strong long-term value play. Its current operating margin of -18.62% trails similar size market participants like Approach Resources (NASDAQ:AREX) and Venoco (NYSE:VQ), at 20.58% and 4.49% respectively. Additionally, industry revenue growth rates of 29.1% greatly outpace HERO at 7.8%.
One positive aspect of the company that investors may want to take a look at is the low price-to-book ratio of 0.46 times. While not a perfect measure, it may represent an undervalution of the stock by the market.
Management has been focused on maintaining a slimmed-down cost profile in the face of rising cost environment in order to compete in the industry. The success of this is imperative if the company wants to restore investor confidence and boost stock price.
Kodiak Oil and Gas Corp (NYSE:KOG)
KOG currently trades close to the midpoint of its 52-week range and has displayed extreme volatility in recent periods. With a beta of 3.45, the company remains one of the riskier stocks among competitors. While the company isn’t a buy for all investors at this point given its risk profile, it may prove attractive for investors willing to put up with volatility in the near term.
The company has delivered strong sales growth of 122.68% during the past 5 years and grew earnings per share by 26.09% in the past year. This historical pattern of growth bodes well given the projected future demand for oil in the United States and abroad. Still, when compared to competitors like Northern Oil and Gas (NYSEMKT:NOG) and Unit Corp. (NYSE:UNT), KOG offers unattractive margins. With operating margin of 15.19%, KOG trails both NOG (27.09%) and UNT (27.17%) and offers a lower profit margin as well. It does, however, best the industry average of just over 11%.
The risks related to the industry and the volatility of KOG’s stock price may outweigh the potential for growth for many investors, and while we are monitoring this stock, it is not a buy at this point.
Patterson-UTI Energy, Inc. (NASDAQ:PTEN)
After a strong run-up in price during the first half of 2011, PTEN has seen its market capitalization drop almost 47% in less than 3 months. At a price to earnings ratio of 11.81 times, PTEN may prove inexpensive relative to many in the industry (industry average of 14.93 times). Among similar sized competitors like Nabors Industries (NYSE:NBR) and Rowan Companies (NYSE:RDC), which have price to earnings ratios above 20 times, PTEN may be a strong play.
PTEN offers strong fundamentals, something that should be attractive to value investors. The company is expected to see triple digits earnings growth and continue the financial momentum from its strong second quarter. After second-quarter numbers came out, the price per share surged to over $34 before retreating to current levels below $20. This sell-off may represent a buy opportunity. General weakness in the stock market (investors fearing risk-on trades) has pushed PTEN down with the overall market. Second-quarter earnings per share of $.52 beat the consensus on the street of $.48. Revenue doubled for the second quarter of last year $600 million from $307 million. If the company continues to perform at this level, getting in at the current price levels may be a bargain.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.