Why You Should Buy These Depressed Stocks in Oil & Gas

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

While safety is attractive at first site, it much more often than not comes at a high price. For investors willing to take on risk, the potential for upside is much more real given how discounted the fundamentals typically are. As oil & gas resources become increasingly scarce, investors will benefit from backing firms that are doubted by the market but nevertheless have large holdings to tap. Below, I review three companies--two of which I believe are undervalued and one of which I believe is quite expensive.

Chesapeake (NYSE: CHK) & Marathon Oil (NYSE: MRO) Both Undervalued

Over the last year or so, Chesapeake has gone through a series of PR scandals surrounding corporate governance. Ironically, many of these "scandals" aren't really scandals at all. Things like the CEO backing wells being developed by the company showcase not a conflict of interest but rather confidence in the fundamentals. In short, tailwinds are thus being factored in as headwinds.

While the company carries a significant amount of debt, the parts are worth more than the whole. Even if Chesapeake has a weak bargaining power, it can sell off prized assets to return to a solid financial position. I anticipate the closing of the midstream deal  for $2 billion cash in 3Q followed by one in the Permian, which could generate proceeds of upwards of $4.5 billion. Possible buyers include Devon, Shell, and Exxon. In the meanwhile, the firm's $4 billion bridge loan has proven that management has good connection with financiers to navigate macro uncertainty. Greater cash holdings will also enable the company to secure more attractive financing going forward.

In addition to improving the firm's financial position, asset sales will also refocus the business more into an E&P operator with plays in Utica, Eagle Ford, Miss Lime, Marcellus, Barnett, Haynesville, and PRB. Joint ventures, like the one being explored in Mississippi Lime, will also help the company mitigate risk, and thereby encourage investor entry.

Marathon Oil similarly has excellent fundamentals that are under-appreciated. The market continues to be myopically focused on quarter-to-quarter business, as it eyeballs today's low gas prices as definitive proof that natural gas has no future. What they fail to consider is not only the greater amount of commerce that is being made for natural gas, but that Marathon is less effected due its long-lived production and stable base. Eagle Ford continues to see rising volumes and, with $3 billion in asset sales planned, the company will have plenty of cash to reinvest elsewhere.

The market also fails to consider the capital expenditures are ultimately investments and are budgeted for a future return on invested capital. On one hand, greater debt load may put downward pressure on the Baa2 rating and thus limit growth opportunities during a full recovery. However, it is unlikely for the financial position to come down to this given the firm's conservative management.

ExxonMobil (NYSE: XOM): Safe But Overvalued

Unlike Chesapeake and Marathon, Exxon, probably by virtue of being the largest producer in the field, has mostly tailwinds factored into the stock price. As a result, it is able to trade at a premium to peers. Unfortunately, what glitters isn't always gold. While Exxon may offer strong safety, it is overvalued based on a present value analysis.

Analysts forecast around 5% annual EPS growth over the next 5 years. Even if the company trades at a multiple of 12x, an 8% discount rate would dilute all of the upside. Accordingly, if you are looking for a value investment, Exxon is not for you.

On the other hand, the company has some of the best, if not the best, managed facilities with key exposure to growth markets. As a superior capital allocator, the future of the business lies in improving efficiency to pass on savings and grow volumes. Experience with large projects will enable the company to meanwhile compete in a world where much of the remaining resources are controlled by governments. While many firms have to thus fear resource nationalization abroad, Exxon is likely to be the best partner for foreign countries fearful of reckless operators. Accordingly, I recommend Exxon mainly for risk-averse investors but not for value investors.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, short JAN 2014 $17.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. 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.

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