3 Oil & Gas Stocks I Love

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

If you are looking to get into the oil & gas sector, now is a great time to do so. Speculation over a macroeconomic double dip has largely died down while the prospects of entering a full recovery have yet to be appreciated. With greater industrial activity comes rising energy demand. I recommend betting on the overly beaten down stocks that are just as likely as the majors to profit off of this rising demand. I also recommend looking at stocks that will be selling off assets to secure stronger balance sheets.

Chesapeake (NYSE: CHK) & BP (NYSE: BP): Buy What's Evil?

It's no secret that the media likes to pick on Chesapeake and BP. With all of the talk about hidden hedge funds, devastating oil spills, and conflict of interests, you may have forgotten that both of these companies actually have really, really good fundamentals.

For one, Chesapeake sits on leading natural gas plays. Unlike the largest natural gas producer (Exxon), Chesapeake is more leveraged towards the energy resource as a percent of business. The market has been overly negative about the prospects of cold weather, while failing to consider that rig effectiveness has gone up. Chesapeake is boosting its infrastructure to capitalize on improving margins and pricing.

While the company will have to sell several assets in order to shore up capital for upstream development, operations have been excellent where production is currently underway. It has been reported that the company will sell in excess of 28,000 net acres at Hogshooter Wash and Granite Wash. $6.9 billion of gas fields and pipelines were recently sold to Chevron and Royal Dutch. To put that into perspective, consider that Chesapeake is worth only around half that amount and still retains a diversified asset portfolio!

At only 0.8x book value, the parts are worth more than the sum. Partially developing plays and then selling them, like it did for its stake in Barnett, will help the firm gain the cash necessary to tackle safer plays.

BP similarly has strong fundamentals, but has been overly beaten down from poor corporate press. It trades at only a respective 8.1x and 8.2x past and forward earnings, with a dividend yield of 4.4%. Analysts forecast the company to grow EPS by 3.2% annually over the next 5 years - much too conservative in light of the 3.9% annual growth rate that was realized over the past 5.

While the company has delivered a string of devastating misses (a 20.6% miss in 2Q 2012 was preceded by a 9.1% miss), it is still cheap against the fundamentals.  Last year, the firm generated $22.2 billion in operating cash flow, and it has $15.2 billion on the balance sheet. Both of these can be used to pursue takeover activity, expand scale, and dilute fixed costs.

Hess (NYSE: HES): Expect Asset Sales Or Spin-Offs To Come...

At 8.2x forward earnings and 0.95x book value, Hess is also worthy of a "buy." Analysts forecast 5.1% annual EPS growth over the next 5 years. Assuming the company meets expectations, 2016 EPS will come out to $7.80. At a 14x multiple, this translates to a future stock value of $109.06. Discounting backwards by 10% yields a present value figure of $67.71. This is at around a 20% premium to the current market assessment and merits an investment.

Deutsche Bank has speculated that after Third Point's success in getting Murphy Oil to spin off the domestic retail business, Hess will likely pursue a similar transaction. Operations at Hess's retail division has been questioned and, accordingly, it trades under net asset value. The $18.9 billion company has $1.5 billion in current assets - a figure that is up considerably from $819 million four years ago. If it could sell of its assets to buy back shares or increase the dividend yield to peer levels, the company will likely attract in more risk-averse investors weary about industrial activity. I believe that this strategy is in the works following Murphy Oil's spin off announcement.

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, short JAN 2014 $15.00 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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