8 Deeply Undervalued Energy Stocks to Consider

by: Investment Underground

At the time of writing the eight companies below have fundamentals that the markets seem to be overlooking. We think all of the names below offer substantial value, and we believe a few could actually be priced for a buyout. Here are thoughts on each. As always, use the list below as a starting point for your own due diligence.

Range Resources (NYSE:RRC): Range Resources Corporation explores and produces natural gas in the continental United States. RRC leases 2 million net acres across the U.S., including positions in the Permian Basin, various gas fields in southwestern Virginia Appalachia, and 800,000 acres in the Marcellus Shale, one of the largest shale gas plays in North America. Like GMX Resources (GMXR) and Ultra Petroleum (NASDAQ:UPL), which we have written about extensively in the past, the biggest issue for Range in the future will be persistently low natural gas prices. The revolutionary switch from vertical to horizontal drilling has been a double-edged sword.

Cheap gas is brought to the market due to horizontal drilling techniques that permit more gas to be obtained from each drilling location. The technology is used by many operators now, and thus it is difficult to gauge production levels of competitors as individual operators attempt to balance opportunities to sell at good market prices with somewhat frequent bursts of production from multiple shale plays.

Despite these issues, Range is well-positioned. Range is now mostly positioned in the Marcellus which industry reports show has tight shale formations that are ideal for drilling. Much of the Marcellus is in the Pennsylvania area, which provides close access to the Northeast. The Northeastern U.S. is a substantial consumer of natural gas with very little organic supply outside of western New York. In fact, built and planned liquid natural gas ports in Rhode Island and Massachusetts are in place to satisfy demand in the region.

We think a move toward increased use of natural gas in the U.S. is likely given the cost-related problems faced by solar and wind, and the huge lobbying pushback facing coal and nuclear power. We estimate Range's fair value at $80 for 2012 using a 10.5% discount rate.

Ultra Petroleum (UPL): Ultra leases over 110,000 acres in the Green River Basin of Wyoming and 480,000 over the Marcellus Shale in Pennsylvania. The Green River Basin, where UPL has significant experience producing gas and selling through the Rockies Express pipeline, is a promising multi-layer zone with deeper zones likely to add significantly to existing proven, and very valuable, reserves. UPL has well over 100 exploratory wells in the Marcellus with a third already producing gas for sale. Once natural gas prices firm, we expect Ultra shares to see considerable price appreciation.

We think a buyout would come in around $10-11 billion including debt, or above $60 per share. Ultra is led by Michael D. Watford, a very solid manager in our opinion. Since 1999, he has served as the chairman, president and CEO. Mr. Watford has worked for a number of energy companies including Superior Oil (OTC:SIOR), Shell Oil (NYSE:RDS.A), Meridian Oil and Nuevo Energy. Before joining Ultra Petroleum, Mr. Watford was CEO of Nuevo Energy for 3.5 years where he drove the company’s growth from $200 million to over $1 billion in market value.

Alpha Natural Resources (ANR): With its acquisition of Foundation Coal (FCL), ANR is one of the largest coal miners in North America. ANR has purchased Massey Energy to round out its mining portfolio. The company extracts, processes and markets metallurgic and steam coal everywhere from Colorado to the Central Appalachian region to the Powder River Basin.

Should metallurgic prices remain high into next year, ANR will be in a very solid financial place, providing investors with an opportunity for above average returns.

We think Cloud Peak (NYSE:CLD) also offers much to interested buyers.

Exelon (NYSE:EXC): As the lowest carbon emitter in its industry, Exelon stands to benefit from carbon cap and trade legislation, though uncertainty does exist after the earthquake in Japan.

However, in anticipation for cap and trade, Exelon expanded its clean energy footprint with the purchase of Deere’s wind energy business in a $900M deal in August of last year. We believe the company is readying for more emissions-free regulation as more states lower their tolerance for emissions in power generation.

Exelon also continues to incrementally expand power output at its existing nuclear fleet with plans to add as much as 1,500 megawatts of new capacity to its current 25,000 output by 2017. Cap ex is predictable for this type of investment. Exelon is a utility holding company that provides electricity to 1.6 million customers in southeastern Pennsylvania and 3.8 million customers in Illinois. As well, it provides natural gas retail sales to half a million customers in Pennsylvania. With the largest nuclear fleet of any U.S. utility, Exelon’s 11 nuclear plants in the Midwest and Mid-Atlantic generate 17% of U.S. nuclear power and constitute 80% of Exelon’s generation output. Currently, Exelon yields 5.12%.

On a discounted cash flow basis, we believe shares are worth upwards of $70 apiece. The expiring price caps in Pennsylvania should yield $800 million in incremental margin in 2011. Further, the rate increase requested at ComEd, adding $396 million, and rate settlement at PECO, adding $245 million, will add to gross margin in 2011. We also think Exelon is a dividend king for 2011.

GMX Resources (GMXR): GMX is a smaller operator with around 42,000 net acres in the Haynesville shale in the eastern Texas counties of Harrison, Marion and Panola. Earlier this year, GMXR shifted from vertical drilling in the Cotton Valley Sands to horizontal drilling in the Haynesville Shale. We expect big things out of GMX by year's end once the oil starts flowing.

As a result, the company had to remove substantial proven undeveloped reserves from its books on the Cotton Valley due to its switch to the Haynesville Shale below it, cratering the share price. We think a buyout would come in around $700 million on the low end or $12 per share given GMX's acreage and infrastructure at current gas prices. Devon (NYSE:DVN), legacy XTO, Apache (NYSE:APA) and EOG Resources (NYSE:EOG) all have acreage in East Texas and are looking for opportunistic acquisitions. GMXR acreage, with no impending lease expirations and the ability to place well heads near pipelines due to its Cotton Valley experience, is a potential target.

The company announced in January that it would buy 67,724 net acres of horizontal oil resources within the core development areas of the Bakken/Sanish-Three Forks Formation in the Williston Basin (Bakken) and the Niobrara Formation in the Denver Julesburg (DJ) Basin. The 67,724 net acres include 26,087 net acres in the Williston Basin, North Dakota and Montana targeting the Bakken/Sanish-Three Forks Formation and approximately 41,637 acres in the DJ Basin in Wyoming targeting the Niobrara Formation. In addition, this provides 342 additional horizontal drilling locations.

FirstEnergy (NYSE:FE): FirstEnergy is a large conglomerate of seven electric utility companies. The company serves over 4 million million customers in Ohio and the northeastern US. As well, FirstEnergy owns a generating and marketing subsidiary, First Energy Solutions Corp., and a regulated transmission utility.

The company's power generation assets are 53% coal and 30% nuclear, and the remainder a combo of oil and natural gas and some hydro. On a discounted cash flow basis, we model shares at upwards of $50 a piece. We also believe this stock is a very safe idea for the ultimate retirement portfolio.

ATP Oil and Gas (ATPG): What sets ATP Oil and Gas apart from larger independent exploration and production competitors Andarko (NYSE:APC) and Apache (APA) is significant growth. Investors in the oil and gas space have already forgotten that ATP was nearly a takeover target after General Electric (NYSE:GE) took a look at buying the company last summer. A large part of the value of the company comes from its infrastructure, which, while significant and valuable on a standalone basis, provides a platform that many competitors in the industry are missing. Using replacement cost method for ATP's rigs, the company's flagship rig, Titan, would fetch in the ballpark of $600 million alone. An additional barrel of oil production in the gulf for ATP costs next to nothing now that most major pipeline and well-head initiatives are in place. With Titan financed and other major rigs already drilling or prepped to drill, ATP has further development of positive cash flows to look forward to over the next year.

Cloud Peak Energy (CLD): On the heels of Alpha bidding for Massey, Cloud Peak looks ripe for a buyout. We think shares could fetch $30 apiece and, independent of a buy out, CLD's earnings multiple has plenty of room to expand. Cloud Peak generated $1.37 billion in revenues in 2010, which was a decrease of 1.96%, after rising 12.78% in 2009. The EBT margins in 2010 and 2009 were 15.46% and 18.2%, respectively.

Cloud Peak Energy is the third-largest U.S. coal producer and the only pure-play Powder River Basin coal company. Cloud Peak is led by President and CEO Colin Marshall. Before his appointment as head of Cloud Peak Energy, Mr. Marshall was president and CEO of Rio Tinto Energy America (RTEA) prior to the company’s public offering as Cloud Peak Energy. Preceding RTEA, Mr. Marshall was the general manager of Rio Tinto’s (NYSE:RIO) West Pilbara iron ore operations. He was located in Tom Price, West Australia, where he managed four iron ore mines. We think the company deserves a take-over premium. However the current share price is below fair value on a discounted cash flow basis that ignores any possibility of a takeover. Cloud Peak is the only remaining pure-play Powder River Basin coal company. Any possibility of exports out of the West Coast (likely Washington State's Columbia River) would likely ignite shares. Powder River Basin Coal is low in sulphur content and much easier to mine than Appalachian coal. The Powder River Basin, located in Wyoming and parts of Montana, is far from major metropolitan areas which made the coal less attractive than coal in the high-consumption East. We think that will change once foreign export and railroad infrastructure capabilities expand.

Disclosure: I am long GMXR.

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