What Stocks To Buy Across Energy's Value Chain

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A strong strategy to take if you are bullish on an entire sector is to buy everything from industry suppliers to end-level distributions--that is, buy across the entire value chain. Since I am bullish on energy and particularly natural gas, I encourage buying shares in both the world's largest natural gas producer and the world's largest oilfield service supplier. Below, I review what these two companies are doing to create value despite their tremendous scale and maturity.

Why You Should Buy Schlumberger (NYSE: SLB)

Schlumberger is the leading oilfield service company in the world. It can be found in about 80 countries and it employs more than 115,000 people. The company has the best margins in the market, and it expects them to keep on improving. Earnings per share are expected to increase from $4.25 to $6.09 in 2014. In addition to its leading economic moat, the superiority of the company over others is being attributed to the technology deployed in oil drilling. The company’s new CEO Paal Kibsgaard has introduced a way of leveraging technology and scale in the market to stabilize performance and expand margins. 

In regard to capital allocation, Schlumberger is becoming more shareholder-friendly by virtue of its robust balance sheet. This is evidenced by how the company has been increasing its dividend at an annual rate of 15% to 20%. Its large size also enables the company to better weather macro storms, and acquire undervalued businesses--often in multi-billion dollar deals. Around three years back, Schlumberger decided to acquire Smith International for $11 billion. Smith International is a fellow industry player that manufactures drilling tools. Could another acquisition be in store?

I believe so. Specifically, Weatherford (NYSE: WFT) is an ideal target. Its name has been floating around the likes of GE Capital and other conglomerates looking for greater exposure to energy. Weatherford, however, would generate the most value for Schlumberger, which is trying to take away market share from Halliburton. At 18.7x past earnings, Schlumberger is going to find a hard time justifying its premium, so it makes sense to dilute multiples through acquiring Weatherford for 11.9x forward earnings.  Weatherford has a double-digit growth curve ahead, so it will also add incrementally to the momentum.

How Exxon (NYSE: XOM) Continues To Expand

Exxon is the world's largest oil and gas company in the world, and it is taking several steps to expand without being haphazard. It is expecting to invest in Mozambique’s oil and natural gas that has just been discovered. The exploration director of ENH, Tavares Martinho, disclosed that Exxon, together with Shell, are negotiating with the government, so that they can find their way into the promising oil fields. Natural gas off 100 trillion cubic feet has already been discovered in the region, and there is hope for even more discoveries. Always aware of the politics in oil & gas, Exxon is working hard to see that it gets into the country before its competitors do. Anadarko is already established in Mozambique, so the Standard Oil heir needs to make inroads sooner rather than later.

If Exxon successfully signs the contract with Mozambique’s authorities, its current gross profit is set to improve from the current $118 billion. The company’s cash balance is at $13.1 billion while its debt is at $12.4 billion. The operating cash is at $55 billion and $16 billion of unlevered cash. Exxon also has ongoing business in Russia and Iraq, which makes it an attractive investment. Exxon has made several joint ventures that have increased its influence. 

The Street is also supportive of this iconic company. Exxon is the second most attractive energy investment to hedge funds, as reported by Insider Monkey. In the second quarter, Exxon increased revenues and cut cost compared to the same quarter a year ago. Elsewhere, Exxon is planning to pull out from Iraq and is holding discussions with other major companies as it consider selling its stake. The oil and gas giant is planning to start drilling oil in Kurdistan in 2013. This stream of activity should keep investors glued to the upside, so I encourage buying if you are risk-averse and interested in oil & gas exposure.

TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool owns shares of ExxonMobil. 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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