1 Oilfield Service Stock, 1 Integrated Producer to Buy

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

As an overall energy bull, I encourage buying through the entire supply chain. That mean purchasing stakes in oil & gas producers as well as their suppliers (ie. oilfield service firms). The latter offers an opportunity to invest in more niche areas of the sector. For example, if you are bullish on natural gas, hydro fracking equipment producers are a smart addition. Below, I review one oilfield service firm and one integrated producer.

Despite Weak North American Margins, Halliburton (NYSE: HAL) Is a "Buy"

This leading oil field service company operates in some 70 countries globally and has more than 60,000 employees. There have been noted increases in operating income, and earnings have beaten expectations in four of the last five reported quarters (3Q12 was in-line). In the third quarter of 2012, the consolidated revenue was $7.1 billion. The consolidated operating income also dropped from $1.2 billion in the previous quarter to $954 million. There was reduced activity in the US and increased costs, but domestic business was not nearly as bad as expected and even offset unexpected political issues abroad. For the fourth quarter of 2012, the company said that it would host its conference call on Jan. 25. 

The company is in a good financial state and has a debt to equity ratio of 0.24 and cash worth $2 billion. Halliburton is continually increasing its global presence through strategic acquisitions. Though the company and the industry have experienced problems in terms of low prices for natural gas, there is hope for improvement as prices / futures have occasionally risen. The demand for natural gas has also increased significantly and most plants that are powered by coal are shifting to natural gas. The US is expected to become the next world leader in oil production. This, however, calls for sophisticated methods of extraction. Halliburton, being a leader in this region, is poised to benefit from this.

So, while much of the optimism may be on Schlumberger (NYSE: SLB), investors have more reasons than ever to diversify more towards Big Hal. Unconventional resources are expected to make up 50% of North American production over the next decade, and it's Halliburton, not Schlumberger, that will be the main beneficiary of this by virtue of its leading hydro fracking business. At a respective 11.7x and 12.2x past and forward earnings, this premium supplier is at a substantial discount to Schlumberger's 18x and 15.2x multiples. I believe these multiples will come to equilibrate, which means considerable upside for Halliburton from here. And, in terms of growth rates, Halliburton is expected to grow EPS around 100 bps faster at 17% over the next five years. I therefore believe Schlumberger's advantage in being the largest international oil & gas firm is overblown.

A Look at Suncor's (NYSE: SU) Trends & Problems

Suncor is a Canadian-based oil & gas company that focuses on synthetic crude oil. It has been using strategic acquisitions as a way to get to the top. The $21 billion acquisition of Petro-Canada in 2009 made Suncor the second largest company within all of Canada.  In the first quarter of 2012 Suncor had $1.457 billion in net earnings.

2012 got off to a weak start with a decline in operating earnings due to reduced production. Though production was reduced significantly, operating cash flow still increased, albeit nominally, due to higher prices. Cash flow from operations in the first quarter of 2012 was $2.426 billion compared to $2.393 billion in 1Q11. 2Q12 earnings were $2.258 billion compared to $980 million in 1Q12, which was attributed to increased production. In 3Q12, operating profit was $1.303 billion while net earnings were $1.6 billion. Cash flow from operations was $2.74 billion. From this data, it is evident that Suncor has been making progress, and the management is positive that that the company can keep up the good trend.   

One major headwind comes from supply disruptions in oil sands. Many of Canada's oil pipelines are full, which could delay production. At the same time, domestic oil supply is putting pressure on Canadian crude prices. But, in my view, Suncor has less vulnerability to margin pressure, since it has taken proactive steps to cut costs and increase rail shipments and refinery output. With investors focused on weak November production of 312 kboe/d (due more to unexpected maintenance work), I believe the market could be in for some positive surprises that will lead to Suncor outperforming.

At a respective 11x and 10.2x past and forward earnings, Suncor is very cheap. Analysts are bullish on the stock with a consensus rating of 1.8 out of 5 where 1 is a "strong buy." Just a 5.5% EPS growth rate is expected over the next five years, which is quite weak, but when complemented with a 1.5% dividend yield and reasonable multiples expansion, it is enough to cause the stock to outperform.

TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool recommends Halliburton Company. The Motley Fool owns shares of Halliburton Company. 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. Is this post wrong? Click here. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.

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