By Matt Doiron
Energy prices are currently low, with oil at about $86 and natural gas trading between $3.50 and $3.60. However, our expectation is that global growth will resume at some point over the next several years and power energy demand higher. This will likely drive prices up- unless production rises substantially as well, which would also be good for energy stocks. We've come up with five stocks that give a long term investor access to dominant oil companies at what are currently attractive prices and to the exciting opportunities in shale, where production should be high for decades to come. We've focused on oil and gas- while there are potential value opportunities in coal stocks, they come with considerable risks; renewable sources aren't quite cost effective yet and investors can be burned by new developments in wind or solar technology. Here are our five energy stocks for long-term investors:
Cheap oil majors. The obvious pick here is BP plc (BP), which we think that the market is still punishing for the Deepwater Horizon disaster. Now paying a dividend yield of 5.1% and with both its trailing and forward P/E multiples coming in at 8, we see it as undervalued. BP's business has also been holding up well, with earnings rising in the third quarter versus a year earlier, and the company is making good progress in selling assets to meet any legal demands. We would, however, be wary of putting too many eggs in the BP basket and so would also recommend that investors look at the more reliable Exxon Mobil Corporation (XOM). At a market cap of over $400 billion, Exxon Mobil is about three times BP's size by that metric. Its earnings multiples are appropriately higher- in the 10-11 range- but given the company's market position (including a strong exposure to natural gas) and a moderate dividend yield, it probably deserves that premium and so looks undervalued as well (read our case for how Exxon Mobil could beat Apple (AAPL) and Google (GOOG) to a $1 trillion market cap).
Halliburton. Halliburton Company (HAL), the $30 billion market cap oilfield services company, has strong business opportunities as drilling activity heats up in the onshore U.S. Its earnings have actually struggled recently, but we think that it should be able to capitalize here. It's also fairly cheap at ten times earnings- on both a trailing and a forward basis. Wall Street analysts expect an average earnings growth rate of 15% over the next five years, which pulls its five-year PEG ratio to 0.7. Perhaps the analysts are being a bit optimistic, but even if Halliburton falls a bit short of these targets it should prove a good value. Like Exxon Mobil and BP, Halliburton was one of the ten energy stocks hedge funds were crazy about in the second quarter of 2012.
Shale. In addition to buying an equipment and services stock like Halliburton, we'd recommend gaining access to the actual production from these fields. As a result, we'd suggest one shale company focused on oil, including in the Bakken play, and one focused on gas, including in the Marcellus. Continental Resources, Inc. (CLR) is the former and Chesapeake Energy Corporation (CHK) is the latter. Continental's earnings multiples are in the teens, even though its revenue and earnings have been growing at double-digit rates and it is a leader in the Bakken. The five-year PEG ratio here is 0.8, so again a slight underperformance of sell-side expectations would still leave it a good value stock. Chesapeake is, in our view, the riskiest of these five stocks but we think that it's worth it to capture an upside in natural gas. The company is striving to finish asset sales this year in order to meet cash needs, after having perhaps overextended itself a bit in its rush to develop new fields. We expect that over time, production and rising prices will give investors confidence in the company and generate multiple expansion (it currently trades at 14 times forward earnings estimates) as well as increase the bottom line (see our analysis of Chesapeake).