Don't Listen To Bears, Buy This Stock

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

With energy companies trading at a historical low, it is an ideal time to invest in the sector. I say this not solely because multiples are low but because the economy is recovery and will outweigh the recent decline crude oil prices. More specifically, I encourage investing in companies that are managing shareholders's capital in a way that focuses on driving returns above the cost of capital. Below, I review 3 stocks with these considerations in mind.

Don't Listen To The Bears, Occidental Petroleum (NYSE: OXY)

Over the last 12 months, Oxy's stock has fallen around 20% and is well below the 17x 5-year average PE multiple (excluding outliers) at just 10.4x past earnings. Though the company is expected to have a 3-5 year EPS growth rate of 3.8% (half of the industry average), these multiples look to be too much of a discount. According to one Oppenheimer analyst, Oxy has a strong track record of execution but its lack of both exploration potential and a steep growth curve represents a substantial headwind. Deutsche Bank has similarly become more bearish amidst signs of rising capital expenditures and lower volume. But, in my view, this is not reflected in third quarter results, where revenue of $5.97 billion was $550 million ahead of consensus.

In the third quarter, domestic product increased by 7,000 boe/d to a rate of 469,000--an 8% rise in production over the same quarter last year and in-line with management's internal target. Sequential growth was driven in the Permian and Williston basins. Latin American and Middle East volumes were 32,000 and 265,000 boe/d, respectively. Middle East volumes have also offset higher spending levels. Shifting towards domestic production also helped lower the effective tax rate to 38%. Moreover, in contrast to analyst expectations, Oxy has forecasted for lower capital spending next quarter. The only reason it was so high in 3Q12 was because management wanted to prevent inefficiency in the areas where momentum has been experienced, such as the Permian. At the same time, the company will cut back on gas drilling and getting rid of the less productive rigs.

While it is disconcerting that European and Asian economies have proven to be less resilient as expected while natural gas costs rise, management is still creating value for shareholders. Specifically, the company has guided for returns that are "5 to 6 points above [the] cost of capital". In addition, management remains focused on only investing if it could generate higher returns than just handing it back out to shareholders. For ever $1 in retained free cash flow, the company has reinvested for $1.50 in value. Should the company not deliver, it has said it will pay out more to shareholders--something it has already done a good job at in light of the 15.8% compound growth rate of the dividend over the last decade.

Hess (NYSE: HES) Vs. Valero (NYSE: VLO)

Hess trades at a respective 11.1x and 8x past and forward earnings versus corresponding figures of 15.9x and 6.7x for Valero. A more clear difference can be seen in that Hess is 17% cheaper than book value while Valero is priced at book value. The two have more or less the same market capitalization, yet Hess is forecasted for 9.1% annual EPS growth over the next 5 years--a rate that is ~240 bps higher than Valero's. But does Hess's lower multiples and faster growth rate mean that you should invest in it over Valero?

Assuming Hess meets expectations, 2016 EPS will come out to $8.07. At a multiple of 13x, this translates to a future stock value of $104.91. Discounting backwards by 10% yields a present value of a little more than $65, or a 30% premium to the current market assessment. The planned sale of its Russian subsidiary also is a catalyst because shareholders have responded very negatively to greater capital expenditures boost. Put differently, by scaling back, shareholders will have greater assurance that management won't  "empire build" but, rather, yield free cash flow returns that are above the average cost of capital. In addition, existing operations have showcased strong performance, as evidenced by (1) how 177 out of 186 branded NYC stations were still operating despite Sandy and (2) production rising around 17% to 402,000 boe/d.

Valero has been lower costs to improve margins and will intend on spinning off the retail operations. The sale of the retail business, which includes convenience stores and gas stations, may bring in $3.5 billion. At the same time, it has been converting downstream Aruba operations to a lower cost hub. However, operational performance has been very weak. Several units have been shut down for maintenance, and, in early October, the company even had to suspend gasoline business in the California spot market as a result of refinery outages and the concomitant product shortage. When combined with the weaker growth forecast, I strongly recommend preferentially buying shares in Hess.

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