Value Remains in Energy Exploration

 | Feb 25, 2014 | 9:00 AM EST
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After two months of see-saw action, equities are almost exactly where they began the year. As I said in Monday's columnI believe this back and forth action will continue for a while.

The market feels fairly priced here. Values are certainly harder to find than they were at this time last year when the market was around 25% lower.

I am still finding attractive valuations in the domestic exploration and production space. Energy production in this country continues to grow unabated, infrastructure is being built to bring this production to market and E&P companies are getting more efficient in getting this production out of the ground.

I realized the efficiency element recently, although I have not seen many stories in the financial press about it. If an investor goes through analyst reports and investor presentations, it appears these firms are successfully driving down well costs and decreasing the time it takes to drill a well.

To cite one example, Chesapeake Energy (CHK) took 29 days to drill a well in its Eagle Ford acreage at an average cost of $10.1 million in 2011. The company estimates that in 2014 the time to complete that same well will be down to an average of 14 days at a cost of $6.4 million. I have seen similar trends at other E&P firms and this bodes well for improving margins across the industry.

It also is one more reason to own this sector, in which I am overweight. In today's column I would like to do a quick rundown of my favorite plays by market capitalization in my portfolio.

ConocoPhillips (COP) continues to be my favorite among the domestic energy majors. It does not have the refinery operations or significant cost overruns at its major projects as does Chevron (CVX). Conoco also does not have the same problems replacing production or possess the chemical operations that rival ExxonMobil (XOM) has to deal with.

Conoco is a pure play E&P concern with a growing focus on geopolitical stable North American production. It is seeing substantial production growth from its acreage in the Permian, Woodford and other energy basins in the United States. The stock yields a robust 4.3% and goes for 11x forward earnings.

Devon Energy (DVN) is my favorite mid-major in 2014. I recently profiled its turnaround strategy that is starting to get traction so I will not rehash the investment case for Devon. The stock has shot up in the last month and I believe it will deliver similar robust returns to what Hess Corp. (HES) was able to deliver in 2013.

I own a variety of small and mid-cap plays in this sector including Warren Resources (WRES), Abraxis Petroleum (AXAS), Oasis Petroleum (OAS) and Rosetta Resources (ROSE).

 My favorite speculative play in this area is fast growing Emerald Oil (EOX).This Bakken-based energy producer has a market capitalization of under $500 million. It is also setting up to be a nice 2014 story. Revenues should roughly double this year over 2013 levels.

Earnings should also swing from an over 60 cents a share loss in FY2013 to post an over 20 cent a share profit in the coming fiscal year. Emerald is also one of most undervalued plays in the Bakken, based on the value the market is putting on it based on a per acre basis it controls in this region. The company has no net debt and a substantial amount of net cash on the balance sheet.

The energy sector can be more volatile than the market overall due to its dependence on energy prices and other company specific factors. My strategy is diversified well across both market caps as well as exposure to the numerous different fast growing energy regions in the country.

As the nation marches toward energy independence, this E&P space should provide myriad opportunities to ride this energy boom to prosperity.

Columnist Conversations

I reached out last week to my close friend Ken Shreve, who is a prominent writer for the IBD.  I asked Ke...
I reached out last week to my close friend Ken Shreve, who is a prominent writer for the IBD.  I asked Ke...
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