2 Oil & Gas Buys, 1 Major Sell

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Includes: CHK, SU, VLO, XCO
by: Takeover Analyst

What follows is a list of oil & gas companies. The Street is most bearish about EXCO Resources (NYSE:XCO) and rates it closer to a "sell" compared to the other firms, but I still believe the company has impressive fundamentals. In fact, investors willing to swallow the risk will gain unusually high returns should an upside story materialize quicker than expected.

Over the last half decade, the industry has suffered from political instability, foreign monopolization, poor end market demand, broader macro headwinds, and intense competition. Now that a full recovery is nearing sooner than what many economists anticipated, past hinderances are becoming less of a concern. Accordingly, I have become a significant bull on the entire sector - especially where natural gas is concerned - and anticipate peer outperformance. While EXCO has the potential to generate high risk-adjusted returns and Suncor offers the most stability, Valero, in my view, is the best-positioned to gain from a full recovery. Its sheer size and vertical intergation allows it to optimally maximize returns. All ratings are sourced from T1 Banker.

EXCO Resources

EXCO is rated closer to a "sell" than the other two and trades at a respective 86.8x and 52.1x past and forward earnings with a dividend yield of 2.1%.

Consensus estimates for EXCO's EPS forecast that it will decline by 39.3% to $0.34 in 2012 and then 41.2% more in the following year. EXCO is an ideal activist target given underperformance, the SEC subpoena, and the fact that the role of Chairman & CEO is not split. Chesapeake's (NYSE:CHK) announcement that it was reducing the amount of drilling rigs to be idled helps set the tone for a turnaround. I recommend EXCO only for speculative invests.

Suncor Energy (NYSE:SU)

Suncor is rated near a "strong buy" and trades at a respective 12.2x and 8.7x past and forward earnings with a dividend yield of 1.3%.

Consensus estimates for Suncor's EPS forecast that it will decline by 8.3% to $3.31 in 2012 and then turnaround to grow by 14.2% and 5.8% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $3.71, the rough intrinsic value of the stock is $40.81, implying 22.4% upside. The company had stellar conclusion to 2011 with 325K barrels of oil sands production. From its low-cost E&P portfolio to its relatively limited exposure to regions plagued with political instability, Suncor is a safe oil & gas pick.

Valero (NYSE:VLO)

Valero is rated a "buy" and trades at a respective 7.6x and 6.6x past and forward earnings with a dividend yield of 2.1%.

Consensus estimates for Valero's EPS forecast that it will grow by 6.2% to $3.59 in 2012, grow by 15.6%, and then decline by 24.8% in 2014. Assuming a multiple of 10.5x and a conservative 2013 EPS of $4.06, the rough intrinsic value of the stock is $42.63, implying 52.3% upside. Valero is one of my top picks in light of the hydrocracker projects debut in the second half of 2012. Capex is likely to become more efficient, which will me a major driver of improving free cash flow. Further, net debt is expected to decline by around $2B over the next three years, hitting $4.7B in 2015.

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

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.