By Patrick Watson

Following last week’s launch of an Oklahoma-focused ETF (OOK), yesterday (11/4/2009) the same firm introduced its Texas version. TXF Large Companies ETF (TXF) is the second offering from OOK Advisors.

Three upcoming investment themes for discussion:

• Policy shift into natural gas by Congress may become more likely with a return to even mediocre US growth and rising oil prices. Also as the dollar drops, oil becomes less affordable and a domestic solution is needed (priced in dollars and produced 100% in America). With massive budget deficits, huge natural gas discoveries in the US driving prices down, and an urge by Congress to "create new jobs", this may be a policy action whose time has come. The economic and national security reasons for this action might make investments in this area start to pay off. A bill to provide for infrastructure for a conversion of the US trucking fleet to natural gas should start to get a lot more support. As that shows success, a follow on to convert the auto fleet may be possible. Autos and trucks account for 70% of all US oil imports. Natural gas is the one solution that can solve our oil problem. Huge discoveries in North America and elsewhere make a transition to natural gas for trucks, and then eventually cars, a much more viable solution for our oil dependence. At some point as oil starts to rise and the disparity between the two increases, I think we'll see much greater investment in natural gas. Investment wise this one can look at plays that own natural gas in the US, as well as exploration, and more speculative bets like Clean Energy Fuels (CLNE) and Westport (WPRT) which makes engines that use natural gas.
• China is due for a hiccup. Lots of stories leaking out about increases in bad debt. Does this mean I think China is due for a huge drop? No, but there are macro problems with excessive lending and an imbalanced currency. Through this crisis we have had the Chinese currency fixed to the dollar. As the dollar drops, this kills Europe and Japan. The Chinese either have to start to revalue higher, or pressure on the ECB and the Japanese will become politically untenable. You can't have a fixed rate regime in the world's third largest economy with major imbalances created (again). Something's got to give. If Warren Buffett wants to buy a railroad, I like Australian plays better than US plays.
• Health Care. Stocks were up on elections. Don't bet against a bill here. Use today's uptick to get out. I prefer to stay out of the sector--but I know quite a few hedge funds that go in whenever hype is high, then go short when hype is low. I prefer to stay clear of musical chairs for a song that I am fairly sure I know will end badly for the insurers.

Disclosure: Author is long APC, DVN, CHK, WPRT, CLNE and looking for more as a long term play.

• Buffett buys Burlington for a cool $44B. Berkshire Hathaway (BRK.A) announced it will acquire the 77.4% of Burlington Northern (BNI) it doesn't already own for $100/share in cash and stock - a 30% premium to Monday's close of $76.07. The transaction is worth $44B, including $10B in outstanding debt. Here's what Warren Buffett had to say: "Our country's future prosperity depends on its having an efficient and well-maintained rail system. Conversely, America must grow and prosper for railroads to do well. Berkshire's $34B investment in BNI is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry. Most important of all, however, it's an all-in wager on the economic future of the U.S. I love these bets."
• Stocks slide; futures fall. Global stock markets painted a gloomy picture Tuesday, with bourses in Asia and Europe taking 2%-plus losses as risk appetite took a breather and investors clamored for safe-haven assets, sending the dollar and U.S. Treasurys climbing and futures tumbling (see data below in Today's Markets). "The basis for the correction seems to rest on three legs," Merrill economist Bill O'Neill said. "Worries over prospects for holders of equity in banks; concern that interest-rate hikes are imminent; and paradoxically, that recovery in 2010 will be crippled by a U.S. consumer unwilling or unable to open his or her wallet." Others took the recent downturn as a sign equity prices had gotten ahead of real improvements in the economy.
• Stanley, B&D craft $8.4B merger. Stanley Works (SWK) agreed to buy rival Black & Decker (BDK) for $4.5B in stock, the culmination of a courtship that spanned 27 years and three other attempts. The bid values B&D at about $57.57/share, a 22% premium to Monday's close. "The more we talked, the more we felt like these were two very complementary and unique companies," BDK CEO Nolan Archibald said, adding both CEOs were "totally swayed" by potential synergies of $350M. Stanley shareholders will own about 50.5% of the combined company; B&D shareholders will get 49.5%.
• Lloyds, RBS diverge on aid. Lloyds (LYG) and Royal Bank of Scotland (RBS) unveiled agreements with the U.K. Treasury over their participation in its program to insure toxic assets, and detailed the divestments they will need to make to satisfy EU regulators. Lloyds opted out of the expensive U.K. asset-protection scheme, saying it would raise £21B, including a £13.5B rights issue; the government will maintain its 43% stake in the bank. The move subjects Lloyds to more modest EU demands: Lloyds said it will dispose of "a retail banking business" with a 4.6% market share and about 19% of its mortgage portfolio; sell £180B in noncore assets; and limit acquisitions over the next 3-4 years. RBS will enter the asset-protection scheme to insure £282B of its illiquid loans, with the first £60B in losses borne by RBS. The government will inject another £25.5B into RBS, raising its stake to 84.4%. RBS will sell its RBS retail network in England and Wales and NatWest branches in Scotland; RBS insurance; Global Merchant Services; and its stake in RBS Sempra Commodities. LYG +2.8% premarket. RBS -8%.
• Outflows continue to plague UBS. Shares of UBS (UBS) are -7% premarket after the Swiss bank said it doesn't expect client inflows to recover anytime soon due to its mangled reputation as a result of its tax dispute with the IRS. UBS posted a fourth straight quarterly loss of 564M francs (-$552M), worse than the 207M loss expected by the Street. Total client outflows rose to 36.6B francs ($35.8B), led by a doubling of outflows at its Americas wealth-management division. On a media call, CFO John Cryan cited UBS's "residual reputational issue" along with "some morale issues among advisers" that it needs to face, and said UBS expects "modest outflows from Swiss clients until we return to profit."
• EU sees gradual recovery. The EU lifted its 2010-2011 growth forecast to 0.75% and 1.5% respectively, but cautioned its outlook is "highly uncertain" given that "significant fiscal and monetary policy measures" are supporting the recovery. Predicting government deficits will swell to 7.5% of GDP, the Commission said a "protracted period of fiscal consolidation will have to follow at some stage to put public debt back on a sustainable footing."
• RBA hikes rates again. Australia's central bank, the first G-20 member to break from super-loose monetary policy, raised interest rates for the second time in two months - to 3.5% - amid a rapidly improving economic outlook. The bank hinted it may not boost rates again in December, saying the rises in October and November would work to temper inflation and ensure a sustainable upswing in the economy, which sent the Aussie dollar (ETF: EWA) lower. The central bank has never hiked rates three months in a row.
• CRE breaks death spiral. Prices of investment-grade commercial real estate rose 4.4% in Q3, according to the MIT CRE's transaction-based index, possibly signaling an end to the sector's year-long downward spiral. "One quarter does not a trend make and we are still well below normal trading volume," David Geltner, director of research at MIT/CRE, said. "Nevertheless, this is the strongest sign of a bottom that we've had in two years." The positive news comes in stark contrast to gloomy remarks from the Fed's John Greenlee, who said Monday (.pdf) that regional banks building up "unprecedented concentrations of CRE loans" will suffer the impact of worsening conditions in real estate markets, and warned, "Poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions."
• Hat trick of upside surprises. U.S. manufacturing activity hit its highest level in 3.5 years and pending home sales contracts unexpectedly surged, reducing fears the economy's budding recovery would falter. ISM's manufacturing index climbed 3.1 points to 55.7 (vs. 53.3 consensus) as companies began rebuilding inventories. "Overall, it appears that inventories are balanced and that manufacturing is in a sustainable recovery mode," ISM said. Pending home sales rose for the eighth straight month, the longest streak on record, with NRA's index gaining 6.1% (vs. +0.7% consensus) to 110.1. The index is now at its highest since Dec. 2006. And construction spending (.pdf) rose 0.8% (vs. -0.3% consensus) to an annual $940B, though the gain was offset by a large downward revision to August's number.
• Pensions bulge while market caps shrink. Pensions rose an average of 19% for top executives in 2008, even as their companies' stock prices fell by 37% amid a global downturn, according to an analysis of SEC filings. The growth was largely due to arcane pension formulas that have received little scrutiny.

Earnings: Tue. Before Open

• Alpha Natural Resources (ANR): Q3 EPS of $0.47 beats by $0.09. Revenue of $729M (+5.9%) in-line. Shares -0.9% premarket. (PR)
• American Tower (AMT): Q3 EPS of $0.17 in-line. Revenue of $444M (+8.5%) vs. $430M. (PR)
• AmerisourceBergen (ABC): FQ4 EPS of $0.44 beats by $0.04. Revenue of $18.27B (+9.7%) vs. $18.06B. Shares +5.5% premarket. (PR)
• Archer Daniels Midland (ADM): FQ1 EPS of $0.77 beats by $0.20. Revenue of $14.9B (-29.5%) vs. $17.9B. Shares +0.1% premarket. (PR)
• Cameron International (CAM): Q3 EPS of $0.58 beats by $0.05. Revenue of $1.23B (-18.1%) in-line. Shares -0.3% premarket. (PR)
• Cognizant Technology Solutions (CTSH): Q3 EPS of $0.45 beats by $0.04. Revenue of $853M (+16.2%) vs. $806M. Sees Q4 EPS of $0.45 vs. $0.42 and revenue of at least $880M vs. $830M. Shares +6.9% premarket. (PR)
• Emerson Electric Company (EMR): FQ4 EPS of $0.67 beats by $0.07. Revenue of $5.32B (-20.5%) in-line. Sees 2010 revenue of $19.45-19.87B vs. $20.21B. "We are well positioned for economic recovery, but the shape and speed of the recovery remains unknown and we expect weakness to continue in the near-term." Shares -1% premarket. (PR)
• Expeditors International of Washington (EXPD): Q3 EPS of $0.27 misses by $0.02. Revenue of $1.04B (-33.7%) in-line. "There certainly were significant challenges during the latter part of this quarter as both air and ocean carriers imposed capacity reductions in order to implement very aggressive price increases. While we wouldn't call it 'The Perfect Freight Storm,' the rapidity of these carrier moves created a pricing environment that resulted in our experiencing single digit airfreight yields out of Asia during the first several weeks of September. Ocean yields were also significantly impacted." (PR)
• Frontier Communications (FTR): Q3 EPS of $0.17 beats by $0.02. Revenue of $527B (-5.6%) in-line. Shares -0.3% premarket. (PR)
• Gaylord Entertainment (GET): Q3 EPS of -$0.32 misses by $0.21. Revenue of $199M (-12.2%) vs. $202M. (PR)
• IntercontinentalExchange (ICE): Q3 EPS of $1.18 beats by $0.03. Revenue of $256M (+27.3%) in-line. Shares +0.2% premarket. (PR)
• Marathon Oil (MRO): Q3 EPS of $0.61 beats by $0.04. Revenue of $14.48B (-37.9%) vs. $13.7B. Shares +1.3% premarket. (PR)
• Marvel Entertainment (MVL): Q3 EPS of $0.26 beats by $0.02. Revenue of $106M (-42.1%) vs. $92.5M. Disney (DIS) is due to acquire Marvel by year-end. (PR)
• MasterCard (MA): Q3 EPS of $3.48 beats by $0.54. Revenue of $1.36B (+1.9%) in-line. Gross dollar volume +0.3%. Purchase volume +0.4%. Shares +3.3% premarket. (PR)
• Medco Health Solutions (MHS): Q3 EPS of $0.75 beats by $0.03. Revenue of $14.79B (+17.8%) in-line. Shares +2.5% premarket. (PR)
• Northgate Minerals (NXG): Q3 EPS of $0.03 misses by $0.01. Revenue of $120M. (PR)
• Oshkosh Truck (OSK): FQ4 EPS of $0.27 beats by $0.11. Revenue of $1.49B (-19.8%) vs. $1.4B. "We expect to be solidly profitable in fiscal 2010, led by significant revenue growth in our defense business, which should more than offset anticipated low demand at our construction-related businesses." Shares +3.8% premarket. (PR)
• Petroquest Energy (PQ): Q3 EPS of $0.07 misses by $0.06. Revenue of $50.3M (-35.8%) vs. $52.2M. Shares -6.5% premarket. (PR)
• Polo Ralph Lauren (RL): FQ2 EPS of $1.75 beats by $0.44. Revenue of $1.37B (-3.8%) vs. $1.31B. "We are raising our sales expectations for the remainder of the year, but we continue to be cautious with our outlook and are planning accordingly." Shares +2.7% premarket. (PR)
• Rockwell Collins (COL): FQ4 EPS of $0.84 misses by $0.03. Revenue of $1.19B (-7%) in-line. Shares -2.7% premarket. (PR)
• Royal Caribbean Cruises (RCL): Q3 EPS of $1.07 beats by $0.07. Revenue of $1.8B (-14.5%) in-line. Sees "a slight loss" in Q4 vs. consensus of +$0.04. "Like many other travel companies, we saw more strength than we expected during our peak season but have been experiencing more pricing pressure on some of our traditionally softer fall season sailings." Shares -3.2% premarket. (PR)
• St. Joe Company (JOE): Q3 EPS of -$0.08 misses by $0.02. Revenue of $43.2M (+30.1%) vs. $28.9M. (PR)
• Teva Pharmaceutical Industries (TEVA): Q3 EPS of $0.89 beats by $0.01. Revenue of $3.55B (-7.6%) vs. $3.63B. Shares -2% premarket. (PR)
• Viacom (VIA): Q3 EPS of $0.69 beats by $0.12. Revenue of $3.32B (-2.7%) in-line. Shares +0.7% premarket. (PR)
• Vornado (VNO): Q3 FFO of $1.25 beats by $0.08. Revenue of $671M (-0.7%) vs. $637M. Shares -0.5% premarket. (PR)

Earnings: Mon. After Close

• Anadarko (APC): Q3 EPS ex-items of $0.40 may not compare to estimate of -$0.33. Gains that may affect comparability, including reversed accrual and unrealized derivatives loss, of $0.51/share. Revenue of $2.7B (-55%) vs. $2B. Shares +0.7% AH. (PR)
• Avis Budget Group (CAR): Q3 EPS of $0.54 misses by $0.01. Revenue of $1.5B (-14%) vs. $1.6B. Shares +6.5% AH. (PR)
• Axis Capital (AXS): Q3 EPS of $1.05 beats by $0.33. Revenue of $452M (-29%) vs. $581M. (PR)
• Chesapeake Energy (CHK): Q3 EPS of $0.70 beats by $0.05. Revenue of $1.8B (-76%) vs. $2B. Shares -1.1% AH. (PR)
• Forest Oil (FST): Q3 EPS of $0.48 misses by $0.04. Revenue of $177M (-50%) vs. $252M. Shares -1.8% AH. (PR)
• Hecla Mining (HL): Q3 EPS of $0.09 beats by $0.09. Revenue of $95.2M (+39%) vs. $68.7M. Shares +2.4% premarket. (PR)
• Kinross Gold (KGC): Q3 EPS of $0.00 misses by $0.12. Revenue of $582M (+16%) vs. $578M. Shares +0.4% AH. (PR)
• MannKind (MNKD): Q3 EPS of -$0.42 beats by $0.06, on no revenues. "While we continue to be fully engaged in the task of navigating our NDA through the FDA review process, we are continuing to run additional studies of AFRESA." Shares +4.5% AH. (PR)
• Republic Services (RSG): Q3 EPS of $0.32 misses by $0.04. Revenue of $2.07B (+149%) in-line. Sees full-year EPS of $1.46-1.48 vs. $1.46. Shares -0.2% AH. (PR)
• Principal Financial Group (PFG): Q3 EPS of $0.74 beats by $0.09. Revenue of $2.3B (-9%) vs. $2.5B. Shares +2.4% AH. (PR)
• St. Mary Land (SM): Q3 EPS of $0.23 beats by $0.03. Revenue of $186M (-43%) vs. $187M. (PR)

Today's Markets

China was the lone gainer on an otherwise dismal Tuesday in Asia. Europe shares are getting pummeled. Stock futures are under severe pressure. Treasurys and the dollar are up strongly.

S&A Resource Report editor Matt Badiali covers a broad expanse of ideas as well as geography in this exclusive interview with The Energy Report. He discusses the immense potential of Iraqi oil, and the smaller but surer resurrection of old oil fields in Illinois. In addition to sharing views about areas within the oil industry worthy of investors' attention, he talks about the promise—and problems—associated with major oil finds that have been making the news. These discoveries may postpone peak oil by a decade or two, but they will take a long time to bring to production, too. Matt also points out how data reporting metrics (BOE) manage to hide the extent of dwindling oil production.

The Energy Report: When we interviewed you six months ago, you were talking about some new oil finds in the Tupi field off the coast of Brazil. Since then another big oil field has been identified offshore of Sub-Saharan Africa. Can you speak to these finds and what they will mean to the oil sector?

On the strength of favorable exploration results and in the context of a rising stock market, buy-recommended Anadarko Petroleum (APC) has appreciated beyond a McDep Ratio of 1.0 where stock price matched Net Present Value (NPV) of $59 a share. The potential for increasing NPV and the momentum of the market justify continued buy interest, in our opinion. Yet, investors overweight in APC might rebalance toward lower McDep Ratio recommendations.

Today the company announced that the Venus well drilled offshore Sierra Leone is an oil discovery. Though it is too soon to declare commerciality, Anadarko technologists are excited about the value of the information obtained. The well confirms the promise of the Liberian Basin where Anadarko has 6 large acreage blocks (see slide from management presentation below). Referring to the general area as a Cretaceous Fan Play last month, APC now refines its disclosures to map a separate Liberian Basin and Ivorian Basin. The latter has the billion barrel Jubilee field under development by APC and partners. In the two basins the company has about a 40% share in some 30 leads to potential discoveries.

The founders of the Galleon Group, a hedge fund started in 1997 and which has a technology and healthcare focus, have been charged with insider trading. Galleon is one of the 250 hedge and institutional investment funds that are available on AlphaClone. The fund's Top 10 Holding Clone, which invests quarterly in the the fund's ten largest holdings at the time they are disclosed, is up 48.2% so far this year but has not performed very well over time returning a negative 3.9% annualized over five years and a dismal negative 18% annualized since 2000 (all returns as of 10/15/09 close). We thought we'd list the fund's 50 largest holdings below (as of 6/30/09). Now that the fund will almost certainly wind down, perhaps there are some good short opportunities.

Ranked #3 on Forbes' Best Brokerage Analysts for 2009, Oppenheimer Senior Analyst Fadel Gheit sat down with The Energy Report to shed light on existing conditions in the oil and gas sector. In terms of oil prices, "financial players are more in control now than oil companies or OPEC," according to Fadel, who is currently more bullish on gas than on oil. "Despite the fact that gas stocks gained significantly this year," he says, "we think the upside potential remains great."

The Energy Report: Why is there such a high ratio and differential between natural gas and oil right now?

As noted earlier, Friday marks the two-year anniversary of the S&P 500's closing peak. As of Thursday's close (10/8), only 57 of the 500 stocks currently in the index are up since then. Needless to say, it has been a lousy two years. Below we highlight the 25 best performing stocks in the index over the last two years. As shown, sectors which are the most heavily represented include Technology (7), Energy (6), Consumer Discretionary (5), and Health Care (5). Check back Friday morning for a list of the top performing Mid and Small Cap stocks since 10/9/07.

click to enlarge

The Jubilee oil field offshore Ghana was discovered by Tullow in partnership with Anadarko in 2007. It's a remarkable story in several respects. The deepwater Tano Basin had been previously surveyed and drilled by Phillips in the 1970s, by Arco in the late 1980s, and successively by Amoco, Hunt, and Dana Oil in the 1990s based on two 3D seismic surveys commissioned by Ghana's national oil company. Tullow did a splendid job of finding a reservoir that everyone else missed.

Privately-held Kosmos Energy LLC of Dallas was awarded a block in 2006 that overlaps about 2/3 of Jubilee and became an investment partner with Tullow and Anadarko. I haven't looked at the details of that deal, but Kosmos had $100 million in private equity cash to fund four exploration wells.

Repsol YPF is a direct beneficiary of Anadarko's (APC) recent oil discovery off the coast of Sierra Leone. The short interest (as measured by Percent Shares Outstanding On Loan) for Repsol Ypf Sa (REP) has decreased 27.79% over the past week and now stands at 2.34%. This is down 84.5% from the 52 week high hit on July 13, 2009. Even though the short interest has decreased over the past week, when compared to other Europe Oil Gas & Consumable Fuels companies, the short base is well above the average of 1.83% for the sector.

Over the past week the Negative Sentiment Indicator (DNS) for REP saw a small increase to the sixth decile. The DNS for the security is now neutral indicating an increasing amount of negative short sale sentiment. The Price Squeeze Indicator (DIPS) remained unchanged and continues to be in the first decile which indicates a low probability of a price squeeze.

United States Natural Gas Fund Is Terrible Paper (UNG), Devon (DVN), Apache (APA), Anadarko (APC), Linn Energy (LINE), First Trust’s ISE-Revere Natural Gas (FCG)

Buy-recommended Anadarko Petroleum (APC) offers unlevered appreciation potential of 11% to a McDep Ratio of 1.0 where stock price would equal Net Present Value (NPV) of $59 a share. On July 14 we reduced NPV from $70 when we reduced estimated Present Value of North American Natural Gas by 20%. Released today, second quarter results exceeded our estimate for unlevered cash flow (Ebitda) from three months ago. Reduced operating expense raised cash flow margin to account for most of the positive surprise.

Oil surpasses natural gas to drive more than half of NPV in our valuation that capitalizes cash flow at unlevered multiples (PV/Ebitda) related to reserve life (Adjusted R/P). Not counted for much yet in NPV, a billion barrel discovery offshore Ghana has opened what management describes as a new frontier area. APC has a 40% interest in 10 million acres in the Cretaceous Fan play where it is currently drilling the Venus prospect, one of multiple targets in the billion barrel class.

This is the second quarter 2009 edition of our ongoing hedge fund portfolio tracking series. Before reading this update, make sure you check out our series preface on hedge fund 13F filings.

Next up is T. Boone Pickens' hedge fund, BP Capital Management. He runs an energy-centric set of funds out of Dallas, Texas and is a big advocate of Peak Oil Theory. On the positive side of things, he has landed himself on Forbes' billionaire list. Yet on the negative side of things, he also graced the list of top hedge fund manager losers of 2008.

Five large cap buy recommendations concentrated on North American natural gas, Anadarko Petroleum (APC), Devon Energy (DVN), Encana (ECA), EOG Resources (EOG) and XTO Energy (XTO), have demonstrated volume growth on a basis that takes account of financing (see chart Volume per Share, Adjusted for Debt and Dividends, below). All have low McDep Ratios ranging from 0.72 to 0.91 with the top growers of the latest quarter coincidentally having the higher McDep Ratios.

Stock prices are in an uptrend by the 200-day average measure despite intense short-term pressure on the price of the companies’ main product, clean natural gas. Potentially rebounding economic activity in 2010 may demand the new volumes not needed today for industrial production or power generation. The large cap North American natural gas independents account for 5 of our 28 buy recommendations. We suggest that one or more might account for 18% of enterprise value in a McDep Energy Portfolio, or perhaps 24% if you like the prospects for natural gas as much as we do.

This is the second quarter 2009 edition of our ongoing hedge fund portfolio tracking series. Before reading this update, make sure you check out our series preface on hedge fund 13F filings.

Next up is John Griffin's hedge fund Blue Ridge Capital. Griffin is very similar to Stephen Mandel (whom we also just covered) in that they were both some of Julian Robertson's top men at legendary hedge fund Tiger Management. They both went on to form their own funds and as such are labeled 'Tiger Cubs.'

Oversupply

Recent reductions in natural gas (NG) price may be related to continued strength in production capacity, specifically in unconventional shale gas fields. The Potential Gas Committee estimated U.S. reserves are 35% higher than just two years ago, thanks to new technology that has allowed producers to drill for gas in shale rock. The committee estimated the country's total natural gas resources at 2,074 trillion cubic feet, an increase of 542 trillion cubic from its last report.