Energy Companies: Top 3 Volume Gainers

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Compared with the year-ago period, first-quarter operating and financial results for the energy companies I usually follow were mixed, with higher earnings for the refiners but mixed results for integrated and exploration and production (E&P) companies. Despite mixed financial results, almost all E&P companies increased production.

Within this group, there are three that did this the most: Marathon Oil (NYSE: MRO), Anadarko Petroleum (NYSE: APC) and Southwestern Energy (NYSE: SWN). Let's see if you should add these companies to your watch list.

Favorite pick among volume gainers

Marathon's production gains are sustainable. The company achieved its 22% output gain through ramping up production in the Eagle Ford and the Bakken Shale areas. Besides this, the company is reducing costs and improving operating efficiency. I expect all this (better costs and increased production) to boost Marathon Oil's earnings and cash flow outlook. As a matter of fact, Marathon is expected to generate free cash flow of more than $700 million this year and $900 million in 2014 (a 28% year-over-year increase).

With two-thirds of its production being oil and liquids (compared with 47% for its peers), Marathon should be on your watch list. The company trades at 2013 10x P/E and 4x price-to-cash flow. Besides, I would expect Marathon to lift its cash dividend up from the low 2% yield the company is currently paying.

An exploratory champion with a high price tag 

Anadarko Petroleum has one of the most successful offshore exploratory programs in the industry. Besides, the company has some of the most prized US onshore unconventional assets. The company increased volumes by 13% year-over-year and I think it is close to settling Tronox litigation in a favorable way.

Tronox argued that Anadarko left the company insufficiently capitalized after acquiring its parent, Kerr-McGee. Ultimately, Tronox is blaming Anadarko for the financial troubles and bankruptcy that followed Anadarko's acquisition. I do not think the courts shall agree on that.  

Besides, a bad outcome in the Tronox case shouldn't take more than 3% off the company's value, a figure which is very far from the $14 billion that Tronox was Initially claiming.

Hence, Mozambique gas development and continued exploration successes are more relevant to Anadarko's valuation than any result at the courts.

With all of that said, I would rather have Marathon as an investment. First of all, Anadarko's volumes are far less liquids-rich (57% gas, 32% oil, 11% NGLS) but, most importantly, because the valuation is much richer. Anadarko trades at 2013 20x P/E and 5x price to cash flow. Besides, the company pays an extremely low 0.4% cash dividend yield. 

A pure gas bet somewhat over-priced

Southwestern Energy is a pure US onshore gas play and the one with the highest production growth rate in the country. The company has a high capital discipline and one of the lowest cost structures within the industry. Southwestern's volumes rose 11% year-over-year despite having fallen by 1% sequentially. The company's operating strengths are matched by its rich valuation which, in part, can be explained by the potential earnings boost that could come from higher US gas prices.

As the US becomes a net gas exporter, local gas prices should surge making Southwestern's earnings soar. But, even if higher gas prices are almost certain for the future, the market shall remain oversupplied for at least the next two-to-three years. With that in mind, I think Southwestern, which trades at 2013 19x P/E, 7x price-to-cash flow and pays no dividend, looks relatively expensive.

Bottom line

The three stocks above have great prospects. Not only do they represent the equity side of successful exploratory firms with great management teams but also because the US E&P industry will be one of the most prone sectors to M&A in the years to come.

The US is going through an energy revolution that is changing the world energy map much faster than many thought possible. It is extremely relevant to have an eye on the sector and these three companies should be on your list of firms to follow. That said, its also relevant to have valuations in mind. As a result, I think Marathon represents, at current market prices, the most compelling company within this group of three.   

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Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Think you can do better? Join us and write your own!

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