Energy Stock Review: 3 Undervalued Buys

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Includes: BTU, VLO, WMB
by: Takeover Analyst

What follows is a list of energy companies with various degrees of upside. They cover a variety of different industries: coal, integrated oil & gas, and oil & gas. In my view, coal firms are significantly undervalued given overblown bearish sentiments on the resource. With multiples near a historic low, these high beta stocks are likely to recover much of the lost value over the recent month(s). While Peabody (NYSE:BTU) and Valero (NYSE:VLO) offer cheapness at the cost of greater risk, Williams (NYSE:WMB) offers stability at the cost of high multiples. Overall, I recommend diversification across all three firms.

Peabody

Peabody trades at a respective 6.7x and 7x past and forward earnings with a dividend yield of 1.4%. Consensus estimates for Peabody's EPS forecast that it will decline by 29% to $2.67 in 2012 and then grow by 35.6% and 19.9% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $3.59, the stock could rocket to $43.08 for 70.3% upside.

Coal faces significant volatility and some are even skeptical about the secular trends given environmental regulations. In turn, this has set the bar so low that I believe reward far exceeds risk. Even discounting backwards by a highly aggressive rate of 15% finds the intrinsic value to be $32.57, which is at a 28.7% premium to today's value. In short, the bears shouldn't overstay their welcome.

Valero

Valero trades at a respective 8.1x and 4.9x past and forward earnings with a dividend yield of 2.8%. Consensus estimates for the company's EPS forecast that it will grow by 15.1% to $3.89 in 2012, grow by 14.9% in 2013, and then fall by 16.3% in the following year. Assuming a multiple of 7x and a conservative 2013 EPS of $4.44, the stock would hit $31.08 for 41.9% upside.

This integrated oil & gas company is selling cheap given that it trades under book value and well under its historical PE multiple. This comes even at a time that the company has improved margins. Over the last three months, the stock has fallen 13.9%, underperforming the S&P 500 by 1,144 basis points. With a beta of 1.42, it is well positioned to recover lost shareholder value when the economy returns to full employment.

Williams Companies

Williams trades at a respective 23.1x and 18.7x past and forward earnings with a dividend yield of 3.4%. Consensus estimates for Williams' EPS are that it will grow by 19.5% to $1.53 in 2011 and then by 15.7% and 16.4% in the following two years. Assuming a multiple of 21.5x and a conservative 2012 EPS of $1.69, the rough intrinsic value of the stock is $36.34 for 19.5% upside.

While this oil & gas company may not be the cheapest in its sector, the high dividend yield showcases management's confidence over free cash flow. Frequently, energy companies are free cash flow negative during weak economic times due to the high costs of well development, resource acquisitions, and so forth. Williams is strong in this regard with $643M in free cash flow for FY2011 and $3.4B in operating cash flow. I thus recommend Williams for risk-averse energy investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer.

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