These Energy Stocks Are Unloved, for Now

 | Mar 13, 2013 | 3:00 PM EDT  | Comments
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It is no secret that I have some pretty strong views on U.S. energy policy. I believe that we are somewhat foolish to direct most of our resources toward allegedly green sources of energy. The goal has to be energy independence and a strong economy first, and that means using the massive supplies of coal, natural gas and oil that we have access to in our country and in Canada.

Someday we will figure out how to produce, and more importantly store, energy from the sun and the wind, but that day is not here. We need to focus on digging and drilling as well as finding cleaner ways to use our already abundant resources.

My views on energy have almost nothing to do with why energy plays such a big part on my "buy now" list. The oversupply and underutilization of natural gas has weighted on the all-important short-term earnings, and the stocks have been sold. They are cheap on an asset basis. The same holds true for coal right now.

Energy-related names are as unloved as banks and small real estate investment trusts were three years ago, and I expect to see the same results going forward. Energy companies will take capacity off line, some companies will disappear through bankruptcy or merger, and the survivors will become more valuable. The stocks may well go down before they go up, but five years into the future, I believe they will be a lot higher than they are today.

Arch Coal (ACI) is a classic example of my approach to energy stocks. I started buying the stock at around $7, and the stock has continued to decline. I just added a little bit more, as the stock is now at just 40% of tangible book value. The near-term outlook for the stock is horrible as demand and pricing for thermal coal continues to decline. The company has increased its exposure to metallurgical coal, and that should eventually support higher revenue when export demand begins to come on line and reduces domestic supplies. Arch is the second-largest coal company in the U.S., and it should be one of the survivors of the horrid industry conditions.

The near-term picture is not much better for U.S. drillers and exploration-and-production companies. Swift Energy (SFY) is undergoing a transition from a Gulf of Mexico-based exploration-and-production company to an unconventional oil and gas company, and the process is taking longer than some had hoped. The mix of liquids to gas is not tilting toward oil as quickly as projected, and total production volumes are basically flat. However, the company has put together substantial acreage in the fast-growing Eagle Ford shale field, and the stock is extraordinarily cheap at 60% of tangible book value.

WPX Energy (WPX) is also being hammered by lower natural gas prices. Although liquids production rose last year, gas is still 80% of total production. There is talk that the company may sell its 60% interest in Argentina-based Apco Oil and Gas (APAGF) to support s domestic activities. Nabors (NBR) has seen some improvement in its operations and stock price, but the world's largest land-based contract driller is still cheap enough to buy at 90% of tangible book value.

Canadian oil and gas producers have had to deal with the same market and economic issues as their U.S. counterparts, and they have also suffered from an enormous price differential. Canadian companies have no pipeline infrastructure for exporting anywhere but the U.S., and pricing has suffered for that reason. However, plans are under way to redirect or build more capacity to get Western Canadian oil and gas to the coast for export and to the refineries in the eastern part of Canada.

Right now, Canadian oil is the cheapest in the world, selling for about half the cost of Brent and less than 60% of West Texas Intermediate crude oil. That should change over the next decade, and as it does, the stock prices of companies in the region will improve. Right now, I would suggest buying into Penn West Energy (PWE), which trades at 80% of tangible book value and sports a generous 9.5% dividend. If the dividend gets cut, that should provide an opportunity to pick up more shares cheaper. I also like Pengrowth Energy (PGH) as it continues to transform from conventional to thermal production. The stock trades at 80% of tangible book value, and management is committed to maintaining the 8.5% dividend payout.

These are the energy stocks that fall into the "cheap enough to buy right now" classification. There are literally dozens of others, such as Rowan (RDC) and Peabody Energy (BTU), that I like but which are currently trading at small premiums to tangible book value. If they decline to 80% of tangible book in a future market decline, I would be thrilled to increase my exposure to energy on the cheap.

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