3 Oil & Gas Stocks You Should Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the last twelve months, major oil & gas producers have underperformed the market at large. While the S&P 500 gained 20.2%, BP (NYSE: BP), Chevron (NYSE: CVX), and Hess (NYSE: HES) yielded returns of 9%, 17.6%, and -9.9%, respectively. In my view, all three provide attractive buying opportunities. I am particularly bullish on BP as it recovers from a devastating oil spill. The firm trades at overly low multiples and has received bullish ratings on the Street compared to its peers.
BP trades at just a respective 8x and 8.4x past and forward earnings. It also offers an impressive 4.4% dividend yield and is forecast just 3.1% annual EPS growth over the next five years. I believe this bar has been set irrationally low and will help generate high risk-adjusted returns when they beat these expectations. The current price target of $50.04 on the Street is at around a 20% premium to today's market cap and provides significant safety to entering shareholders.
On a fundamental basis, the British oil & gas company is doing just fine. New production will start kicking in near the end of 2013 and into the next two years. BP has beaten producers like Conoco and Chevron in sales growth over the past five years. Despite damages from the spill, the current ratio still bests industry leaders. All of the attention is still being focused on a potential settlement before the 2013 hearing, since the Department of Justice is claiming it has proof that BP was grossly negligent in the January trial, in which BP made a $7.8 billion settlement with individual spill victims.
Although the story has been a bit brighter for Chevron and Hess on the public relations side, the two stocks have less upside. I would still recommend them to investors, but they should represent a smaller part of your portfolio than BP. Chevron is fairly compelling at respective 8.7x and 9.4x past and forward earnings compared to corresponding figures of 15x and 8.4x for Hess. Analysts are projecting below 4% annual EPS growth over the next five years for both firms, which, again, sets the bar low for high risk-adjusted returns. Moreover, Chevron has a very clean balance sheet with little debt and a quick ratio of 1.5x - liquidity that will enable the producer to dilute fixed costs through takeover activity that increases scale. Myanmar represents a particularly attractive regional growth prospect with estimates of 11T-23T cubic feet worth of natural gas complemented by production of 19,600 bbl/day of oil.
On the other hand, the second-highest court in Brazil recently banned Chevron from operating in its country. That's a huge headwind as other firms, like Hess, seek to expand. To offset this constraint, Chevron is not only busy fighting the decision but expanding elsewhere. It recently decided to purchase 246,000 net acres in the Delaware Basin from Chesapeake Energy - a deal which the company probably got at an attractive price given the 2nd largest natural gas producer's soft bargaining power right now.
Hess has had operational problems of its own. They have missed analyst expectations in four out of the last four quarters by an average of 11.3% when those misses occurred. The most recent quarter was fairly strong and, going forward, the spread between cash flow and capex should peak this year and balance around 2013. Profitability on a per-unit basis is likely to go up as industrial activity picks up. Moreover, Libya, which was originally excluded from guidance due to the political uncertainty, has seen production restored. Asset sales (more than $850 million for the year to date) have meanwhile injected the balance sheet with cash, and they will become useful in developing the transition to Bakken. This sets the tone for strong upside during a full recovery.
2012 net production has been guided to an average 54,000 - 58,000 boe/d as capital spending rises 50% to $3 billion. The decision to operate in higher working interest areas will pay off in the long-term, because it will enable HBP drilling to be substantially completed in 2012 and accelerate production growth thereafter. The firm is just laying a foundation in the Bakken, and the more it can set aside for production now, the more it can edge out competitors from the market through reinvesting subsequent cash flow.
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