Playing A Rebound In Oil And Gas: 5 Stocks To Focus On

by: Matthew Smith

The past few months have been painful for commodity investors, especially the past few weeks when discussing the oil and gas E&Ps. With the current economic climate we have been uncomfortable with the idea of going all in, but have begun nibbling where we think there is little risk but plenty of reward. This has included the purchase of deep in-the-money calls on some issues. We are even sacrificing significant yields in some cases to establish positions via LEAPs, in order to gain greater exposure to the capital gains upside we see.

When looking at what we want to buy, we must be clear that all of these entities share a common link, and that is a strong growth profile. Forget strong appreciation in the underlying commodity, we believe that it behooves one to focus upon strong growth in the actual production. It is possible to increase revenues and EPS in a market where the underlying commodity moves lower so long as production continues to ramp up on a sufficient enough scale.

For this reason we like the following five stocks:

Chesapeake Energy (NYSE:CHK) has come under fire recently for a myriad of reasons. The company has been plagued by governance and oversight issues which has been the main reason the shares were hit so hard. The financing/cash-flow issues are a major concern, but when one looks at the assets the company has it is easy to arrive at an answer to the problem rather quickly by doing back of the envelope calculations.

Chesapeake is one of those proverbial battleground stocks where bulls can see no way but up and bears no way but down. Lately the bears have had their way, but we now feel that with the financial mess in Europe coming to the forefront of the news cycle once again that we will have an opportunity to purchase these shares at very attractive prices. We also expect the company to successfully complete the planned asset sales and close this funding gap which exists over the next two years. We say this because our thinking is that things will get worse before they get better and that Europe will rise to the occasion at the eleventh hour to save their monetary union.

We think that this is such an attractive buy because it is our opinion that even after the assets sales that the company will have decades of drilling left and plenty of time to drill out as their remaining land holding will be HBP (held by production). The company will remain a top five driller for many years to come with a success rate which will probably never be rivaled.

SandRidge Energy (NYSE:SD) is another play we like due to their exposure to oil and huge inventory of land to drill. The company announced over the last conference call that they had bridged the cash-flow gap by arranging a credit line and their previous land sales. Thus, investors should not anticipate further issues relating to cash-flow and how the company anticipates getting to self-funding status over the next few years.

Tom Ward is an excellent CEO, and he positioned the company to diversify into the oil and wet gas plays early which has kept SandRidge moving in the right direction. Unlike other E&P plays, the company has kept its landholdings rather simple, deciding to focus on the prolific Permian Basin and the Mississippian Lime. This investors can understand, and the drilling is simple too. In the Permian the company will drill only vertical wells and they will utilize horizontals for the Mississippian. There are some trusts involved here, but for capital appreciation purposes we would stick to the company's shares and not venture into the units. With hedges in place and exciting recent exploration success in the Mississippian it is easy to see this one rebounding strongly once the market puts in a bottom.

If one were to look for a mini-Chesapeake, their search would undoubtedly take them to Gulfport Energy (NASDAQ:GPOR) which has recently come under fire for how their business is tied into other businesses owned by their largest shareholder. Investors have decided to focus upon this rather than their production growth, ramp-up to production in the Canadian oil sands and the exposure that they have to the Utica in Ohio. This is one of those highly volatile stocks with a solid risk/reward scenario. We view the shares as cheap here as they trade near 52-week lows and that so much good news exists out there which is no longer priced into the stock. This one has a tendency to go on runs, and a batch of good news could light the fuse to get this one to rocket higher.

Rosetta Resources (NASDAQ:ROSE) is another interesting one which has unfairly been punished. They have highly sought after acreage in the Eagle Ford Shale and a world-class asset in Gates Ranch, which has thus far been the focus of their drill program there. The company does sport some of the highest well costs of those in the Eagle Ford but we see those coming down eventually as the company streamlines their drilling. We think that the Eagle Ford play alone is a company maker, however Rosetta does possess a wild card in the Williston Basin. To date results have been underwhelming, but the company appears to be pursuing a JV (not very hard at this point) on the project and looking at alternatives. We thought the shares were a steal not long ago as they rose from the $20s to the $30s and even into the $40s, so now that they are back in the $30/share range we have to like the opportunity to acquire shares once a buy signal becomes obvious to us - whenever that may be. With prices for acreage in the Eagle Ford rising, so too does the underlying value in shares of the company and other E&P plays in the area as well.

Talk about falling on hard times. Rarely does one find a stock with the opportunity to nearly double the size of the asset base without taking on new debt or significantly diluting the shareholder base, increase the distribution significantly and take much of the risk off of the table by hedging production and still the stock heads lower. This just happens to be the case with EV Energy Partners, LP (NASDAQ:EVEP) and we are left to wonder what exactly the market does not understand about this one, or if we are missing something rather obvious and material to the entity's future. After all of the research we have put into this one, we think it is the market which is missing the major bull story behind this stock and for those investors willing to be patient and brave the storm they will be rewarded with what we believe will be a double off of these levels over the next two years along with a richer distribution.

Yes this one takes a bit of courage as the oil window in the Utica remains unproven in many parts, but after these shut-ins we suspect that the market will learn that the Utica really is similar to the Eagle Ford as Aubrey McClendon has stated on numerous occasions. In reality that is the only "bad" news to hit the play (the longer than anticipated shut-ins that is) but our view is that anything that increases the productivity and profitability of a well is anything but bad news. This one has a nice distribution and the units currently yield 6.10% which should be enough to entice any investor willing to accept a bit of risk to the units of EV Energy Partners, LP.

We think that these entities are buys on pullbacks for trading purposes and long-term investing. Although we are comfortable with prices right here, we would rather be judicious buyers and spread out our buying programs. It is always best to keep one's firepower at the ready and not utilize it all at once, thus the need to spread buying out over a period of time. In any regard, we believe that EV Energy should be apart of the buying in order to secure the yield and low risk/high reward capital appreciation situation.

Oil could be due for some further declines, but with prices already at $84/barrel we see much of the risk already taken out with oil possibly heading to the $78/barrel range as a bottom. If that is the downside risk that we are facing then current prices for these shares represent attractive entry points and points to a scenario where we may have already seen the worst. Either way these are great companies with what appear to be solid fundamentals moving forward and should represent at least a small portion of an investor's portfolio.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EVEP, GPOR over the next 72 hours. Depending upon prices this morning I may initiate further positions in stocks mentioned in the article.

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