By Guan Wang
We are favorable about the energy sector. We think energy stocks are undervalued as a sector and investors can benefit in the long term by purchasing energy stocks at cheap prices right now. A good strategy for picking great energy stocks is to focus on the stocks favored by T. Boone Pickens, a billionaire who spent decades in the oil fields before turning to money management. Pickens founded Mesa Petroleum in 1956 and sold it after it became one of the largest independent natural gas and oil production companies. Today, Pickens chairs BP Capital, a hedge fund investing in energy stocks and futures. Recently, BP Capital released its holdings as of March 31, 2012 in a 13F filing. Let's take a closer look at some of its most bullish bets.
Encana Corp (ECA) is a new position in BP's portfolio - the fund did not report owning any shares of Encana at the end of 2011 - but it is one of its largest holdings. During the first quarter of 2012, BP initiated a new position in the company worth $18 million. A few other hedge funds also have Encana in their 13F portfolios. At the end of last year, there were 19 hedge funds reported to own this stock. Steven Cohen's SAC Capital Advisors had nearly $100 million invested in Encana (check out Steven Cohen's top stock picks) at the end of last year. Martin Whitman and Ken Griffin are also bullish about this stock.
Encana has been restructuring its operations over the past year. The company divested $2.1 billion worth of its non-core assets in 2011 and it plans to divest additional $3 billion worth of assets in 2012, which is expected to unlock a certain value. On the other hand, Encana spent $515 million in purchasing liquids-rich acreage last year. We are favorable about the company's increasing exposure to liquids. We expect a 20%+ growth in liquids in 2012, partly offset by the potential decline in natural gas productions as natural gas prices are deteriorating. However, natural gas currently accounts for 96% of Encana's productions. Therefore, the impact of the liquids-rich acquisition seems to be far from significant.
Analysts expect Encana to make $0.88 per share in 2012 and $0.67 per share in 2013, versus $0.53 per share in 2011. Priced at slightly below $20 per share, Encana is trading at nearly 29X its 2013 earnings, a premium to its peers. We think some other oil companies, such as Apache Corp (APA) and Devon Energy Corp (DVN), are better options. Apache is priced at 6.3X its 2013 earnings and Devon's forward P/E ratio is 8.8.
Pickens likes Devon as well. The stock is the fourth largest position in his latest 13F portfolio. Pickens boosted his stakes in Devon by 36% over the first quarter to $190 million. Devon is also quite popular amongst the other hedge funds we track. There were 32 hedge funds with positions in Devon at the end of last year. Ric Dillon was the most bullish money manager about the company. His Diamond Hill Capital had $200+ million invested in this stock at the end of 2011. Israel Englander, David Dreman, and Jim Simons are also in favor of Devon (check out Jim Simons' top stock picks).
Devon has also shifted its focus from natural gas to oil and natural gas liquids. We think Devon is well positioned to benefit from the higher margins of liquids. The company's Jackfish heavy-oil development project has been driving its production growth. The Jackfish 2 project is expected to ramp up throughout 2012 and Devon has already filed an application for Jackfish 3 in 2010. Devon also holds 240,000 net acreages in Cana-Woodford Shale and 950,000 net acres in Permian Basin - both have been contributing to Devon's liquids productions. In 2012, Devon's liquids productions are expected to grow by 18%. It also expects to drill 125 wells in 2012, targeting liquids.
As we mentioned earlier, Devon is trading at 8.8X its 2013 earnings, a discount to the industry average of 12.5. The company's earnings are expected to grow at an average of about 10% per year over the next few years. The decent growth makes its valuation looks more attractive. Devon has also been boosting its EPS through share repurchases. The company announced a $3.5 billion share repurchase program in 2010 and completed the program in November last year. It bought back 11% of its total outstanding shares, or 49.2 million shares.
Other large positions in Pickens' portfolio are BP Plc (BP), National Oilwell Varco Inc (NOV), and Transocean Ltd (RIG). Pickens did not increase or decrease his stakes in National Oilwell. He increased his BP position by 12% and his Transocean position by 47% over the first quarter. All of these stocks have attractive valuation levels, especially BP. It is currently trading at only 5.6x its 2013 earnings and has a dividend yield of 5.12%. It is a much better option than long-term Treasury bonds, which yield only about 2%.