3 Oil & Gas Stocks with Different Risk/Reward
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, in general, trading at historically low multiples, there are a few instances where so much optimism surrounds a company that its stock price just can’t help but rise. But this optimism is for growth or a sharper turnaround, there is still a lot of underlying risk. In my view, the appropriate oil & gas portfolio complements risk with a degree of certainty through diversification.
Talisman: A Stock to Avoid
At around 22x past earnings, Talisman (NYSE: TLM) is one of the more expensive oil & gas stocks on the Street. Even still, some claim it is worth the price tag given that analysts expect 29.4% annual EPS growth over the next 5 years. Solid strength in the Eagle Ford shale has helped offset softness in Marcellus. Demand was particularly driven by Asian business, whichgrew 12% year over year to 130,000 barrels per day.
Assuming analyst forecasts are accurate, Talisman will generate EPS of $1.30 in 2016. At a 17x multiple, this translates to a future stock value of $22.10. Discounting backwards by 10% yields a present value roughly in-line with the current market assessment. After EPS had declined by 24.5% annually over the past 5 years, this double-digit growth expectation on an annual basis is, in my view, much too extreme. Accordingly, I recommend avoiding the stock and backing safer and cheaper producers.
EnCana For High Risk-Adjusted Returns; Suncor For Even Risk/Reward
With significant risk comes potentially significant reward. Such is the case for EnCana (NYSE: ECA). Earnings have halved each year over the past 5, and there are more analysts who rate the stock a sell than there are who give it a buy. As attractive as its 3.7% dividend yield is, there are other major integrated oil & gas plays, like BP, that offer higher dividend payouts. I recommend backing them before investing in EnCana.
On the positive side, EnCana has had good momentum of late. Shares are up 32.5% from the 52-week low and keep hovering higher as investors become increasingly confident about the turnaround story. EPS of ($2.17) over the twelve trailing months have, however, put investors like me on the defensive.
Suncor (NYSE: SU), by contrast, has a strong economic moat and is forecasted for just 4.2% annual EPS growth over the next 5 years, setting the bar low for significant returns. It trades attractively at a respective 11.3x and 10.6x past and forward earnings. Assuming expectations are met, 2016 EPS will come out to $3.43. With the current price target pegged at $41.74 and the stock at $32.85, significant upside remains.
And, unlike EnCana, Suncor has solid operating performance that limits downside. After producing strong results in 4Q 2011 and 1Q 2012, Suncor beat EPS consensus by 9.6% with earnings of $0.80 per share. Accordingly, I recommend a larger investment to hedge against uncertainty in EnCana.
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