In part one of this series, we came up with several technology stocks that I have deemed worthy of selling in anticipation of a market pullback. We have established that their gains were due (in part) to the market's "rising tides." For similar reasons, in part 2 we identified 5 financial stocks that may see a near term pullback and then it was followed by a look at healthcare and then consumer staples. In this piece, we are going to look at the energy sector and see which firms may suffer a near term pullback. As with the previous pieces, we started with some basic understanding.
You'll always know that you are in a bull market whenever each trading day follows one where records and weekly, monthly and yearly highs are always mentioned. Where earlier this week both the Down and S&P500 reached key decade-old milestones and yet another on Friday as the Dow surged higher closing near its 4-year high. However, this time it was the Nasdaq's turn after it index hit an 11-year high. This time the optimism was spurred job growth. The U.S. economy created jobs at the fastest pace in nine months in January and the unemployment rate dropped to nearly a three-year low of 8.3 percent, the government said.
Still not convinced we are in a bull market?
Consider this, across all of the sectors trading on the market, there has been 450 separate stocks that have recently reached 52-week highs. This is the highest reported total since last July. In 2012 so far, it seems to be an everyday occurrence. Aside from a company such as Apple (NASDAQ:AAPL) which continues to rise and will likely do so through the quarter, while looking across all of the indices, the signs of being overbought was apparent on a great majority of the stocks that are showing such momentum. A recent analyst suggested that 74 percent of stocks were over their 200-day trading averages. The question now becomes, is it time to be fearful in the market if you follow the preaching of Warren Buffett?
Clearly the year to date sector performance above shows that investors are not only excited about what lies ahead in 2012, but have become decisive about what industries matter the most. So again, with such early gains and with the broader indices having approached record territories, should investors be in a fearful mode and begin to lock in some profits as the bear market may just be around the corner? This question is not that difficult to answer if one has studied recent history.
Trading the sector gains
They say "a rising tide lifts all boats." There is unquestionable truth in this theory especially in the stock market as evident by this bullish run we are now seeing. So when it comes to stocks, we need to understand that a strong economy can propel even the most challenged business models.
In this article, which is the fifth in the series of looking within each sector, we are going to try to identify certain energy stocks that might be on the verge of a pullback and ways to possibly mitigate some risk and exposure to losses. The benefit of this is that if you are on the sidelines, hopefully you will be able to get an idea of a possible good entry point.
A lot has been said recently about dry-gas drilling cuts and its effect on the energy markets. Chesapeake Energy (NYSE:CHK) has led the charge and it appears that many more energy companies plan to follow in their reductions in dry gas drilling for this year as a means to mitigate the low cost of natural gas. For Chesapeake, according to a recent publication, it plans to halve its dry gas drilling by the second quarter, bringing to 12 the number of Marcellus Shale dry gas rigs that Chesapeake operates in the region, primarily in northeastern Pennsylvania. It wasn't immediately clear how many the company had operating now but a spokesman said Monday that Marcellus production would continue. On the subject, the company's CEO said the following:
- "An exceptionally mild winter to date has pressured U.S. natural gas prices to levels below our prior expectations and below levels that are economically attractive for developing dry gas plays in the U.S., shale or otherwise."
The concern in the industry surrounds the fact that weakness in demand suggests that energy companies such a Chesapeake are on the verge of being severely weakened economically if the supply and demand for natural gas does not regain its proper balance. These actions, while drastic might be a great way to help stabilize the falling prices, but just how effective they are remains to be seen. In the meantime, investors will be better served to avoid this situation all together until normalcy is restored and thus higher prices over the long term. Other companies facing similar challenges include:
Continental Resources (NYSE:CLR)
The company recently announced that the company would discontinue drilling in the Arkoma area of the Woodford Shale.
CONSOL Energy (NYSE:CNX)
It has decided to cut $200 million from its capital budget in 2012, lowering spending from $1.7 billion to $1.5 billion for the year. The company cited low natural gas prices due to "mild weather and high production" as the rationale for the cuts.
Safer energy plays
It is hard to value a company like Schlumberger. The company ranks either number one or number two in terms of market share in an assortment of oil service sub segments. These range from services needed during exploration to those critical for drilling and completion. The company is committed to this market dominance and has made several acquisitions when needed to keep pace in oil services. It recently assured investors that it has a clear plan of execution over the next 5 years. Some of which includes growing market share in various oil service lines, growing earnings per share faster than revenue, establishing the highest margins in the business in North America as well as continuing its strong share buyback and dividend policy.
Halliburton often gets mentioned when discussing prominent oil companies, yet with a forward P/E of 8 it intrigues me how the market continues to discount growth potential. From an earnings standpoint, it has steadily demonstrated an ability to beat expectations and deliver on its bottom line. I have a near term price target on the stock of $40 and a 12 month target of $55.
Aside from the benefits it stands to gain as demand increases for more drilling, the company has also been doing pretty well as it relates to its earnings. From that standpoint, there aren't many companies that have fared better and have proven to be more consistent than Halliburton except maybe Apple. It has steadily demonstrated an ability to beat expectations and deliver on its bottom line. It goes without saying that its management will want to continue this trend, and will be doing just about everything under its power to make certain that these types of performances continue.
Exxon Mobil (NYSE:XOM)
What is not to like with Exxon Mobile - the largest company in the world. But it's odd that more investors are enamored with #2. Exxon has huge reserves and plenty of capital which often is an appealing quality to conservative investors. Not to mention that it has a well earned reputation - something that many of its competitors are working hard to rebuild. Investors should keep in mind that Exxon Mobil is still a dominant player even among the big oil companies.
It has nearly three times the market cap of even the other oil giants, but it is hardly a lumbering, stumbling giant. The company is still in the mix of all phases of upstream and downstream operations, and its portfolio of exploration and production projects should make it able to continue to weather these lean times.
Thank you for reading the energy sector stocks in part 5 of this series, in the next piece we will investigate the utilities sector and see which stocks might be on the verge of a pullback.
Disclosure: I am long XOM.