3 Stocks to Buy in the Shale Boom

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

 The shale-gas revolution has brought a new life in many sectors that were otherwise neglected by investors. Energy infrastructure (more commonly known as engineering and construction, or E&C) companies represent one such group. Given the abundant supply of natural gas, economists have suggested the government export some of it, which will not only bring foreign remittances but also help to maintain a balance between supply and demand of natural gas. In this situation, the most important question that is raised is which stocks should be bought in order to benefit from this theme?

Role of energy infrastructure companies in shale gas boom

When it comes to energy infrastructure companies and the shale gas boom, five areas of development are brought under discussion:

1. Gas processing – a process through which natural gas liquids (NGLs) are separated from natural gas

2. Fractionation – it is a process through which mixed NGLs like ethane, butane and propane, are separated into distinct products (and therefore brought into usable condition)

3. Petrochemical – abundant gas supply means cheap NGL supply and therefore cheap availability of ethane. Ethane is used to produce ethylene, which is then used as a cheaper substitute to naphtha and propane thereby providing cheap feedstock to the companies

4. LNG exports – building terminals/pipelines to export LNG

5. Gas power – basic infrastructure is needed to enable companies to use natural gas rather than costly alternatives like coal for energy production

Now that we have a brief idea of the role of energy infrastructure companies, it is important to shortlist the main beneficiaries.

Majority of the projects go to KBR

The resurgence of energy infrastructure spending in North America has become an investment theme in 2013, reflecting potential for a massive amount of spend across petrochemicals, gas-to-liquids (GTL), LNG, and gas pipelines. Industry margins are expected to continue to improve this year, reflecting better utilization and perhaps tighter capacity with North America now in the mix. 

KBR (NYSE: KBR) seems to be one of the main beneficiaries of the shale revolution given that it has been able to win the majority of the projects related to energy infrastructure development in all five fields mentioned above.

On an overall note, KBR remains well positioned for a gradual ramp-up of earnings through the course of the year following the company’s 1Q 2013 results, highlighted by better execution/margin improvement. I am encouraged by KBR’s prudent cost control in the quarter and think that management is doing a good job of containing the company’s recent execution issues.

I am also optimistic regarding KBR’s better margin performance, especially in hydrocarbons, as lower margin projects (Escravos and Skikda) wind down and contribution from higher-margin Ichthys work continues to ramp up. For those who don’t know, Escravos is a project through which KBR processes liquids from gas i.e. gas processing. Similarly, Skikda and Ichthys are projects of converting gas into LNG based in Algeria and Australia, respectively.

A company similar to KBR

Fluor (NYSE: FLR), another E&C company, has also witnessed a similar rally of 25% in the last 12 months like KBR. Still the stock seems to be a cheap one given that it trades at a forward multiple of 12x, which well below the industry average of 14x.

As one of the higher quality names in the E&C space, Fluor is best positioned to benefit from North American energy spend similar to the 2005 through 2008 cycle given exceptional customer relationships. Also, the mining discount will go away as oil and gas comprises a larger portion of the backlog. The mix of work toward areas like petrochemical and GTL should be favorable to overall margins as well.

Should you follow Warren Buffett in this context?

Recently, Warren Buffett’s Berkshire Hathaway reported a stake in Chicago Bridge & Iron (NYSE: CBI). The billionaire believes that the company is well positioned to benefit from the increasing investment into the natural-gas industry.

The company’s guidance for 2013 announced last December was a sheer reflection of the growth that the company is soon going to witness. The company raised both its earnings as well as revenue guidance, stating the shale revolution to be one of the main causes of top- and bottom-line improvement.

Just like KBR, Chicago Bridge & Iron has been able to win solid projects in all five fields of E&C related to the shale-gas boom. The company’s Dominion project on fractionation, William Geismar project on petrochemicals, Freeport project on LNG exports and Entergy’s Ninemile project on gas power show its strong position in the sector (not to mention its acquisition of SHAW Group, which has enabled it to improve its market share in nuclear maintenance-related work).

Final word

Goldman Sachs believes that the shale revolution will bring multi-billion dollar investments to the E&C industry. This means that almost every company in this space will benefit from this capital inflow. However, KBR, Chicago Bridge & Iron and Fluor remain my top picks as shale-gas beneficiaries. 

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Zain Abbas has no position in any stocks mentioned. The Motley Fool owns shares of Fluor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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