Oil & Gas Stocks to Buy, 1 to NOT Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As the economy moves towards full employment, investors should be eying oil & gas. In my view, Valero (NYSE: VLO) is undervalued and well positioned to outperform broader indices. Sunoco (NYSE: SUN), on the other hand, is just the opposite. Here's why:
Valero is fairly cheap at a respective 11.1x and 7.2x past and forward earnings. Although volatility is fairly high at 50% above average, debt is fairly low. The bar has also been set quite low with forecasts for just 5.4% annual EPS growth over the next half decade. Since June, the stock has soared by more than 50% from terrific operations and trends. Fundamentally, the company has more to gain.
Management recently announced that it was planning to separate out its retail business. I believe that this will unlock value, since many investors have failed to appreciate the retail segment that has been "out-shined," not "overclouded," by the refining segment. It is also taking the right steps to better allocate investments through seeking a buyer for the 235 thousand bbl/day Aruba refinery. This refinery is a burden, because it does not run on cheap natural gas. At the same time, I believe that natural gas prices will eventually go up due to foreign policy concerns and more lax regulations over fracking. Chesapeake Energy (NYSE: CHK) is the second largest natural gas producer in the country, and, in my view, significantly undervalued by the myopic thinking of the market. Although some argue that the market is "forward-thinking," the market, including companies themselves, sometimes gets caught up in short-term situations. If you go by the thinking of me and Chesapeake, selling the refinery now because of low natural gas prices is not "forward-thinking."
During the second quarter, management reported multiple records and boosted the shareholder-friendly capital allocation policy. Higher throughput margins in the domestic West coast and mid-continent, as well as the North Atlantic gave rise to a $100 million growth in operating income. At the same time, lower refinery margins in ethanol and the Gulf Coast were concerning.
Production has also risen from a throughput volume averaging up 342 thousand barrels more per day from 2Q11. Acquisitions of the Pembroke and Meraux refineries led to additional capacity and have done well thus far - contributing $130 million in EBIT during 2Q12. Management is thus not only adding accretive scale but improving what it owns through focusing on efficiency and productivity.
Sunoco is similarly led by strong management, but it is too expensive right now at 26.7x forward earnings. Analysts recognize this and rate the stock closer to a "sell" than a "buy" with a price target that is more or less at the current value. With debt-to-equity at 2.8x and little relative free cash flow to support the market capitalization, Sunoco may have to, unfortunately, spend more time on cleaning its current operational position. Debt is nevertheless at 2.3x EBITDA.
In regard to the merger agreement with Energy Transfer Partners, I think much of the upside has already been factored into the stock price and will not meaningfully benefit current shareholder from a closing in the fourth quarter. On the other hand, I am attracted to the company's JV agreement with The Carlyle Group at the Philadelphia refinery. These kinds of partnerships cement Sunoco's influence with wealthy financiers. Fortunately, Sunoco structured the deal well to suit its interests. It will receive cash proceed for liquidating the working capital of the refinery.
I nevertheless recommend holding out at the current moment. Instead, I would buy even more integrated oil & gas companies, like Marathon Oil (NYSE: MRO). Marathon has fallen by 12.2% over the last six months while Chevron (NYSE: CVX) has gone up by 4.8%. This spread in value creation is likely to reverse as investors become more willing to hunt struggling integrated oil & gas plays during a full recovery. Accordingly, investors are advised to buy shares of Marathon now before the value gap closes.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Chevron. 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.
