Going Deep in an Energy Subsector

 | Mar 28, 2013 | 1:00 PM EDT
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The market is about to complete one of its best first quarters in some time. But to say this has been an unusual rally would be an understatement. The rally was led by sectors like health care and consumer staples, among others that are usually considered defensive or "risk off" plays. Traditional "risk on" sectors, like materials and technology, underperformed during the quarter. Energy and industrials fell somewhere in between. Given the uncertainty around worldwide growth, especially Europe, the outperformance of consistent, albeit slow-growing, sectors like consumer staples makes sense. However, valuations for defensive sectors look like they are approaching overbought territory, if they aren't already there.

To be successful for the rest of the year, investors must find and buy sectors and stocks that provide more robust growth opportunities. One sector I continue to like is energy. The U.S. is still in the early innings of a huge increase in domestic oil & gas production. Oil prices remain historically high and natural gas prices have doubled from where they were approximately a year ago. In addition, technology has allowed energy concerns to get production out of areas previously considered uneconomical (e.g., shale) as well as drill deeper and farther from shore than ever before.

Several energy subsectors should see significant growth in coming years. A substantial growth area is finding and developing energy resources two miles or more below sea level. A recent report from Quest Offshore Resources, an industry research consultant, predicted spending on subsea valves, pipelines and cables to build underwater oilfields will grow more than 65% in 2013 year over year. This should benefit a myriad of oil-services companies and their stocks. Let's look at two of them.

Cameron International (CAM) provides flow equipment products, subsea production systems, blowout preventers, and mud pumps worldwide. The company received some good news on the litigation front recently in that it will not face punitive damages in connection with the Gulf Oil Spill of 2010. Cameron should grow revenues in the low- to mid-double-digit rate over the next few years. The stock sports a five year projected PEG of under 1 (.79). Given growth projections, its forward PE of around 16 is more than reasonable. It had the third most orders worldwide for subsea trees in 2012. These complex systems are used to develop and produce oil & gas in deep water.

FMC Technologies (FTI) led the sector in orders of subsea trees (which monitors subsea wells) in 2012 by a solid margin. The company recently landed a $600 million contract from Petrobras (PBR) for 47 trees. It also won orders in March for use in the Gulf of Mexico and Ghana. FMC CEO John Gremp recently said that he expects revenues from these subsea systems to double to $2.5 billion over the next five years. Like Cameron, revenues should increase in the low to mid-double range over the next few years. FTI is slightly more expensive at more than 18x forward earnings after a significant move in its stock price in the first quarter.

I like Cameron here at its current price, and I would love to pick up FMC Technologies on any decent pullback as well.

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