Buy Chevron and This Hated Energy Stock

By David Gould - October 29, 2012 | Tickers: CHK, CVX, XOM | 0 Comments

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There's a heated debated going on in the country over what will be our main energy source as oil depletes. In my view, the best bet is natural gas, which is abundantly located in the United States and is relatively "clean" from an environmental perspective. With that said, there's nothing wrong with oil exposure right now, since a full recovery will create a rising tide that will lift most energy assets.

Chesapeake Energy ) Still Undervalued

If you bought shares of Chesapeake around the mid-May 52-week low, you would have seen a 51.6% return on your investment. Mind you, during this time, the bears were calling the world's 2nd largest natural gas producer "dead in the water," "over-leveraged," "mismanaged", and, my favorite, "corrupt." Usually, once the other side gets to the point where they have to make judgment calls (ie. "corrupt"), it's a good sign that you have won the argument.

Chesapeake has taken several steps to unlock shareholder value since May. First, they listened to the demands of shareholder activist Carl Icahn by appointing several of his representatives to the board. This was ideal in changing the market's perception of a self-interested board, the members of which were lapdogs for CEO Aubrey McClendon. Second, the company started to sell off extraneous assets at a profit much greater than what the market anticipated. The $13.4 billion company generated $4.7 billion in just asset sales for the first half of 2012. Positions sold include those in the Anadarko Basin, Texoma Woodford, and Access Midstream Partners. In fact, the company has done so well in selling off assets that it raised its lower guidance point from $11.5 billion to $13 billion. At a price-to-book ratio of 0.76x, the assets are irrationally worth much more than the sum of the business. In energy, larger operations creates economies of scale.

The cash generation from selling assets will be used to achieve the company's goal of cutting debt by 25% over the next 2 years. This will lower corporate interest expenses and allow the company to better create value. For now, however, the growth opportunities are tremendous and not fully factored into the stock price, as evidenced by the PEG ratio of 0.91x. Accordingly, I recommend buying now despite the rally.

ExxonMobil ) Still for Risk-Averse Energy Investors...

With a history of growing earnings and around half of the market's volatility, Exxon is a very safe stock. But, largely due to its safety, it is not nearly as undervalued as Chesapeake at a PEG ratio of 1.3x and a price-to-book ratio of 2.6x. Moreover, according to Morningstar, despite an equal split between oil and natural gas production, the company is around 70% exposed to oil due to the use of oil-indexed LNG volumes. Since I am more optimistic on the secular trends of natural gas relative to the current trough prices, I thus recommend an investment in Chesapeake over Exxon.

While Exxon has a leading ability to allocate capital efficiency and the leanest operations to survive precipitous declines in commodity prices, management is still overly safe in E&P. Instead, the company is heavily invested in European and domestic markets, which is likely to see depressed downstream business.

... So Buy Chevron ) Instead

If you are looking for a safe but still higher-reward energy play, Chevron is one of the best bets out there. It trades at 8.3x past earnings versus 9.5x for Exxon. It is forecasted for around only 1.4% annual EPS growth over the next 5 years, which is more than 600 bps (and, in my view, irrationally) less than what is forecasted for its peer. This sets the bar low for positive earnings surprises, since Chevron grew earnings by 11.5% annually over the past 5 years. With a dividend yield of 3.2%, a debt-to-equity ratio of 0.1x, and a beta of 0.79, Chevron is thus an ideal investment for investors looking for higher returns from safer stocks.

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