Analyzing Top Three Picks of T. Boone Pickens

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

According to its last 13F filling, T Boone Pickens' BP Capital management had Valero Energy, Pioneer Natural Resources and Southwestern Energy Corporation as its top three holdings. BP Capital manages two funds: Capital Commodity and Capital Equity. Both invest mainly in energy companies in industries such as oil, natural gas, and nuclear power. With this idea in mind ~78% of the fund’s Portfolio is invested in Energy Stocks. Its top three stocks constitute around one third of the total Funds assets: 

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>% of Hedge funds Portfolio</strong></p> </td> </tr> <tr> <td> <p>Valero Energy Corporation</p> </td> <td> <p>11.40%</p> </td> </tr> <tr> <td> <p>Pioneer Natural Resources Company</p> </td> <td> <p>10.80%</p> </td> </tr> <tr> <td> <p>Southwestern Energy Company</p> </td> <td> <p>10.60%</p> </td> </tr> </tbody> </table>

I like Valero and Pioneer among the above three and believe that will outperform in future. However I don't think future position of Southwestern Energy is strong. Now let’s discuss these stocks in detail.

In the beginning of December, Valero (NYSE: VLO) started a new Gulf Coast hydrocracker at its Port Arthur refinery, Texas. This is one of the two new hydrocrackers planned by the company which will mainly produce Diesel. The other one will be operational by the end of 2Q13 at the St. Charles refinery, Louisiana. These projects will increase the distillate yield to ~39% which will be the highest in the industry. It is expected that the company will generate ~$900 million via these projects as profits next year. Currently these hydrocrackers are licensed to produce ~60000 barrels/day, but it is expected that to meet the increasing demand of crude oil, by 2015 company will obtain the permit to produce ~75000 barrels/day. Because of the completion of these projects the company will be able to reduce its Capex by ~$1 billion.

Along with this, early 2Q13 will witness the spin-off initiative for its Corner Store retail marketing segment by converting the same into an independent listed company. Valero will distribute 80% of the new company's stocks to its existing shareholders. There are ~1027 and ~849 Corner Store locations in the US and Canada respectively. This segment of the company maintains an average operating profit of ~$390 million in the last five years. It is expected that the spin-off would create an additional value of ~$1 billion.

Apart from this I expect that the company will generate a free cash flow of ~$4 billion in the next two years which it may use to fund a repurchase program of 20% of its shares. 

Pioneer Natural Resources (NYSE: PXD) has recently announced that three new horizontal wells at Wolfcamp and two at Rocker B showed a 24 hour Initial Production (IP) rate of ~900 Barrels of oil equivalent/day (Boe/d). This surpasses the recent B bench well's average IP rate of ~600 Boe/d at Wolfcamp. Along with that, one of the two wells at Rocker B had an IP rate of ~1338 Boe/d as compared to the average of ~1000 Boe/d of wells at Rocker B. Wells were drilled in the southern portion of the company's location in the University Lands in Upton and Reagan counties and indicates good progress in the area where expectations were somewhat low. The only issue with the announcement is the fact that lateral length and oil contents of the new wells were not disclosed but I believe it will be around the average of existing wells in the acreage.

Moreover, Pioneer is also heading towards a Joint Venture for the southernmost part of Midland Basin which comes to ~200000 acres. It is expected that the JV will be operational by 1Q13. Based on the consistency of Pioneer’s horizontal wells success, the JV is expected to deliver good results. The extra cash or lower capital requirement of Pioneer will help it to focus on delineating the horizontal well potential in northern side of the Basin.

Southwestern Energy (NYSE: SWN) is expecting that it will face headwind in the near future as it announced a not so promising guidance for the coming year. The Capex expenditure for the year 2013, as projected by the company, is ~$2 billion which is down by ~$100 million from 2012's expenditure. Major reason for the reduction is the anticipated downward trend of production from Southwestern's biggest production asset, Fayetteville which is responsible for ~75% of its production. Fayetteville generates ~$890 million per year and the company has dedicated ~$830 in form of Capex. I believe that the company is intentionally keeping the cash flow to near neutral. It is expected that there will be a reduction of ~2% in Fayetteville's production on a year-over-year basis. The decline is in correlation with the reduction in Capex as it is planning to drill ~240 net wells as compared to ~308 last year.  The slight increase in cost per- well is due to less infill drilling and longer laterals with a focus on the more economic location.

Apart from that the company is concentrating more on its Marcellus location which is expected to show a growth of ~150% in 2013. It is expected that the company will drill ~73 net wells this year for ~$705 million as compared to ~52 in 2012 for ~$540MM. Although this growth will result in an increase of ~11% of total production of the company but I feel that this will not be a driving factor for the company's stock as Marcellus will not be able to maintain the same high level of growth rate in the long run. 

In the end, I believe that the new hydrocrackers and spin offs will strengthen Valero's stock, the new wells and joint venture will help Pioneer outperform the market but the reduced Capex and decrease in production of Southwestern's largest asset Fayetteville will result in a weak position of the stock in the short term.


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