3 Oil & Gas Stocks To Consider Buying
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While the oil & gas sector is known for low multiples, there are occasions when growth is so uncertain that it tends to distort multiples. Both Talisman (NYSE: TLM) and EnCana (NYSE: ECA) trade at high multiples and are more speculative investments than Suncor (NYSE: SU), which is forecasted for consistent and meaningful progress. Below, I review the fundamentals of each company.
Talisman (TLM)
Talisman trades at a respective 22.2x and 19.3x past and forward earnings with a dividend yield of 2%. Growth prospects are nevertheless high as analysts forecast 29.4% annual EPS returns over the next half decade. Under such expectations and as evidenced by the PEG ratio of 0.75, growth has not been fully factored into the stock price.
It should be noted that management has significantly underperformed expectations in 4 of the last 5 quarters. EPS in 2Q12 was $0.10, or 16.7% below consensus. Production rose 4% to 435K barrels/day from the same quarter last year. Strength was observed in Eagle Ford, which offset a lower-than-expected base decline in the Marcellus. Perhaps most importantly, the Asian business grew 12% y-o-y to 130K barrels/day.
After the proposed buyout of Nexen (NYSE: NXY) from Chinese producer Cnooc; international businesses, like Talisman, look particularly undervalued. Asian production has been 5K barrels/day higher than previous guidance and, moreover, much of this strength is laterally spread throughout various Asian assets. The company has a lot of untapped potential as there is only one rig in Marcellus and three in Montney. I thus strongly recommend buying shares based on (a) the growth story and (b) the takeover potential.
EnCana (ECA)
EnCana is a very risky business to invest in given EPS losses and negative growth. Over the past 5 years, the business has worsened EPS by the double-digits annually. While the dividend yield is still generous at 3.5%, forward multiples are overly high at 51.3x. According to data from FINVIZ.com., analysts currently rate the stock a 3.2 out of 5 where "5" is a "sell".
While earnings have been generally above consensus over the past 5 quarters, 2Q12 performance was exceptionally weak. EPS of $0.15 was 21.1% below expectations. Despite the weakness, shareholder value has gone up by 12.3%. To get a sense of how poor fundamentals have been, consider that from the beginning of 2Q09 to the end of 1Q11, the company was seeing quarterly negative revenue growth of around -45%. To jump on board now is to bet that the boat will right itself.
While CAPEX has stayed relatively constant (declining somewhat) over the past three years, the company is simply spending too much. Net debt stands at $5.8B, which is more than a third of shareholder value. Even still, the enterprise value is slightly more than 4x EBITDA. Equipped with an attractive portfolio of assets, EnCana is a possible takeover target or liquidation play. I recommend only buying shares on this speculation.
Suncor (SU)
Of the three stocks highlighted in this article, Suncor is my most preferred pick. The Street shares this sentiment and rates the stock a 1.8 out of 5 according to data from FINVIZ.com. Analysts forecast 4.4% annual EPS growth over the next 5 years.
Assuming Suncor meets growth expectations, 2016 EPS should come out to around $3.75. At a 13x multiple, the future value of the stock is $48.75. Discounting backwards by 10% yields a present value roughly in-line with the current market assessment. Thus, growth has been fully factored into the stock price. But that doesn't make it a poor investment - again my 2016 stock price forecast implies an average return of 10%+ without even including the 1.6% dividend yield.
The reason why Suncor is attractive is because earnings are heading in an upwards trajectory. Aside from the fact that the PE multiple is well below the average 5-year level of 23.8x, ROA and ROE have been on the uptick since mid-2009. At around the 65th percentile on these metrics for the industry, management has solid room for progress. Fortunately, the company has delivered. In the second quarter earnings call, management revealed EPS of $0.80 that was 9.6% better than consensus. This followed strong results in 1Q12 and 4Q11. Under such momentum and low multiples, I strongly encourage buying shares now.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
