Are These Oil & Gas Giants Worth the Risk?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have a very sober view of oil and gas companies. They operate in price competitive markets where supply gluts can destroy profitability, and these firms can sometimes become the centers of environmental disasters and other horrible news.

Investors should take these concerns to heart and demand low valuations before investing in oil and gas stocks. We will consider which, if any, big energy companies are attractively priced.

Tanker Glances San Francisco Bay Bridge

Headlines are very real and unpredictable. On Jan. 8, a Marshall Islands-flagged oil tanker Overseas Reymar collided with a tower of the San Francisco-Oakland Bay Bridge. The tanker suffered damage above the waterline but there was no breach of the hull, thus no oil was released, while the Bay Bridge’s “fendering system,” which consists of timbers and steel backing designed to cushion impacts from such hits, saw damage.

Fortunately, an inspection team from the State Transportation Department found neither structural nor foundational damage to the bridge.  All lanes on the bridge remained open to vehicular traffic. San Francisco Bar Pilots port agent Captain Peter McIsaac said the collision was “not a direct hit, more of a glancing blow, from looking at the damage.”

Overseas Reymar had previously unloaded about 350,000 barrels of crude oil at Royal Dutch Shell’s refinery in Martinez and was en route to Esmeraldas, Ecuador when the incident happened.  The tanker, which was chartered by ConocoPhillips (NYSE: COP) in April to ship crude from South and Central America, is now moored west of Yerba Buena Island between San Francisco and Berkeley. The Coast Guard is investigating the collision.

In 2007, container ship Cosco Busan spilled 53,000 gallons of oil when the pilot, who was under the influence of various prescription drugs, slammed the ship into the bridge under heavy fog.

Valuation Considerations

Sane investors need to demand incredibly low valuations to be lured into oil and gas investments. Many of these firms are trading at attractive multiples:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>P/</span><span>FCF</span></p> </td> <td> <p><span>D/E</span></p> </td> </tr> <tr> <td> <p><span>XOM</span></p> </td> <td> <p><span>Exxon Mobil</span></p> </td> <td> <p><span>9.41</span></p> </td> <td> <p><span>0.83</span></p> </td> <td> <p><span>2.44</span></p> </td> <td> <p><span>36.59</span></p> </td> <td> <p><span>0.07</span></p> </td> </tr> <tr> <td> <p><span>CVX</span></p> </td> <td> <p><span>Chevron</span></p> </td> <td> <p><span>9.06</span></p> </td> <td> <p><span>0.9</span></p> </td> <td> <p><span>1.63</span></p> </td> <td> <p><span>333.66</span></p> </td> <td> <p><span>0.09</span></p> </td> </tr> <tr> <td> <p><span>CHK</span></p> </td> <td> <p><span>Chesapeake Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.97</span></p> </td> <td> <p><span>0.73</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.06</span></p> </td> </tr> <tr> <td> <p><span>COP</span></p> </td> <td> <p><span>ConocoPhillips</span></p> </td> <td> <p><span>10.52</span></p> </td> <td> <p><span>1.12</span></p> </td> <td> <p><span>1.5</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.45</span></p> </td> </tr> <tr> <td> <p><span>EPD</span></p> </td> <td> <p><span>Enterprise Products Partners</span></p> </td> <td> <p><span>18.8</span></p> </td> <td> <p><span>1.12</span></p> </td> <td> <p><span>3.74</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.23</span></p> </td> </tr> <tr> <td> <p><span>SU</span></p> </td> <td> <p><span>Suncor Energy</span></p> </td> <td> <p><span>11.05</span></p> </td> <td> <p><span>1.32</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>16.26</span></p> </td> <td> <p><span>0.26</span></p> </td> </tr> <tr> <td> <p><span>TLM</span></p> </td> <td> <p><span>Talisman Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.56</span></p> </td> <td> <p><span>1.26</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.53</span></p> </td> </tr> <tr> <td> <p><span>APA</span></p> </td> <td> <p><span>Apache</span></p> </td> <td> <p><span>12.91</span></p> </td> <td> <p><span>1.86</span></p> </td> <td> <p><span>1.03</span></p> </td> <td> <p><span>517.71</span></p> </td> <td> <p><span>0.38</span></p> </td> </tr> <tr> <td> <p><span>NXY</span></p> </td> <td> <p><span>Nexen</span></p> </td> <td> <p><span>37.43</span></p> </td> <td> <p><span>2.1</span></p> </td> <td> <p><span>1.6</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.48</span></p> </td> </tr> <tr> <td> <p><span>CNQ</span></p> </td> <td> <p><span>Canadian Natural Resources</span></p> </td> <td> <p><span>13.83</span></p> </td> <td> <p><span>2.16</span></p> </td> <td> <p><span>2.6</span></p> </td> <td> <p><span>126.2</span></p> </td> <td> <p><span>0.35</span></p> </td> </tr> <tr> <td> <p><span>DVN</span></p> </td> <td> <p><span>Devon Energy</span></p> </td> <td> <p><span>31.14</span></p> </td> <td> <p><span>2.3</span></p> </td> <td> <p><span>1</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.52</span></p> </td> </tr> <tr> <td> <p><span>ECA</span></p> </td> <td> <p><span>Encana</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.42</span></p> </td> <td> <p><span>2.64</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.39</span></p> </td> </tr> <tr> <td> <p><span>OXY</span></p> </td> <td> <p><span>Occidental Petroleum</span></p> </td> <td> <p><span>11.4</span></p> </td> <td> <p><span>2.79</span></p> </td> <td> <p><span>1.66</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.19</span></p> </td> </tr> <tr> <td> <p><span>APC</span></p> </td> <td> <p><span>Anadarko Petroleum</span></p> </td> <td> <p><span>21.45</span></p> </td> <td> <p><span>2.8</span></p> </td> <td> <p><span>1.9</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.69</span></p> </td> </tr> <tr> <td> <p><span>EOG</span></p> </td> <td> <p><span>EOG Resources</span></p> </td> <td> <p><span>28.53</span></p> </td> <td> <p><span>2.98</span></p> </td> <td> <p><span>2.48</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.46</span></p> </td> </tr> <tr> <td> <p><span>SWN</span></p> </td> <td> <p><span>Southwestern Energy</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>4.19</span></p> </td> <td> <p><span>3.46</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.52</span></p> </td> </tr> <tr> <td> <p><span>PXD</span></p> </td> <td> <p><span>Pioneer Natural Resources</span></p> </td> <td> <p><span>52.35</span></p> </td> <td> <p><span>4.51</span></p> </td> <td> <p><span>2.47</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.63</span></p> </td> </tr> <tr> <td> <p><span>NBL</span></p> </td> <td> <p><span>Noble Energy</span></p> </td> <td> <p><span>48.87</span></p> </td> <td> <p><span>4.6</span></p> </td> <td> <p><span>2.34</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.51</span></p> </td> </tr> <tr> <td> <p><span>RRC</span></p> </td> <td> <p><span>Range Resources</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>7.57</span></p> </td> <td> <p><span>4.55</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.25</span></p> </td> </tr> <tr> <td> <p><span>CLR</span></p> </td> <td> <p><span>Continental Resources</span></p> </td> <td> <p><span>36.24</span></p> </td> <td> <p><span>7.59</span></p> </td> <td> <p><span>5.18</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.01</span></p> </td> </tr> <tr> <td> <p><span>COG</span></p> </td> <td> <p><span>Cabot Oil & Gas</span></p> </td> <td> <p><span>85.29</span></p> </td> <td> <p><span>9.11</span></p> </td> <td> <p><span>4.78</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.51</span></p> </td> </tr> </tbody> </table>

These stocks were ordered by price-to-sales to allow for comparison between firms that are not currently profitable. They were not ordered according to their price-to-book ratios because exploration costs are often capitalized to the balance sheet, and the value of their oil and gas properties may be inflated with the costs of failed drilling projects. Hence, I am skeptical of this price multiple for ranking purposes.

Investors should consider Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX) as buy candidates based on their low price-to-earnings multiples. Chesapeake (NYSE: CHK) is more based on its price-to-sales ratio but is still cheap. It also trades at a low price-to-book multiple, which is worthy of further investigation.

Why is Chesapeake trading at low price ratios? Because it has suffered corporate governance scandals. Investors should be interested in this story because of activist investor Carl Icahn and because the company appears to be making changes.

There have been many governance changes at the firm. Eventually, ConocoPhillips Chairman Archie Dunham replaced McClendon as board chairman. In addition, the majority of the directors were replaced and director compensation was cut by 20%. There is a plan to stop McClendon’s well-investment program by 2014. There were also more symbolic changes, including how McClendon agreed to reimburse the company $250,000 per year for his personal use of the company’s aircraft.

Chesapeake Energy’s board withheld CEO Aubrey McClendon’s annual bonus in response to investors’ criticism of his performance. The board of directors reduced perks, substantially cut incentive compensation, favoring the development of long-term compensation plans tied to executive performance.

Aside from losing $1.07 billion during the first nine months last year, Chesapeake’s net debt increased by 56% during that period to $16.1 billion.  The company’s directors are also investigating if any of McClendon’s personal financial transactions are in conflict with his duties after reports surfaced that the CEO used company-owned wells as collateral for private borrowing.

The board reforms were initiated by the company’s largest shareholders led by Carl Icahn, Southeastern Asset Management and New York City Pension Funds represented by New York City Comptroller John Liu. In a telephone interview, activist investor Carl Icahn said, “We promised that we were going to work hard to achieve positive change, and I think these are positive changes.  And I hope that there will be more positive changes.” 

Shareholders want the company to have positive cash flow, which it had only twice in the past twenty one years.  Chesapeake also launched a cost-cutting program and plans to significantly cut its contributions to charitable institutions, trade associations and political spending by strictly monitoring those payments. Despite reduced margins, the company has maintained its 8.75 cents per share quarterly dividend.


Exxon, Chevron, and Chesapeake trade at significant discounts to their energy peers and to the broader market. Exxon and Chevron are traditional value buy candidates. Chesapeake is a different buy candidate altogether and is more of a play on investor activism.

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