Energize Your Portfolio

 | May 22, 2012 | 1:30 PM EDT
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In spite of recession in Europe and slower growth in many developed markets, including the U.S., commodity prices for energy have remained high. Emerging market demand has stayed strong, and geopolitically driven concerns about possible supply interruptions or contractions are never far from view.

We don't expect to see a major contraction in energy prices in the current environment. If anything, we think there is a greater likelihood of upward moves based on a number of looming global political issues and growing demand from developing economies.

In such an environment, we think that many energy companies offer attractive valuations and prospects.

Chevron (CVX), a leading integrated energy producer, reported solid results for the quarter at $3.17 a share on higher realization prices for international crude oils and liquid natural gas. Analysts expect a record 2012 EPS of $13.38. At the recent price of $99.69, CVX trades for 7.5x 2012's EPS. The stock also pays a 3.6% dividend yield. CVX is expected to outgrow the industry over the next five years thanks to above-average production growth from new fields from Australia, Russia, the U.S. Gulf of Mexico, Brazil and West Africa. 

CVX has one of the best balance sheets in its industry with $10 billion in net cash and more than $120 billion of shareholders equity. It boasts the highest ROCE (return on capital employed) in the industry, even surpassing ExxonMobil's (XOM) ROCE. Based on these favorable characteristics, we expect Chevron's share price to provide investors with an above-average market return in the coming years with less than market risk. It should be a core holding for any energy investor.

Tidewater (TDW), the leading towing and supply boat operator for offshore drilling, reported better-than-expected quarterly results of 66 cents a s hare vs. an estimate of 60 cents based on improving boat demand and day-rate trends. The company's CEO, who we hold in high regard, believes the business is in the early innings of a multi-year up cycle. 

Many of the most seasoned analysts agree and are expecting TDW to be entering a multi-year period of positive earnings revisions as the energy industry steps up its offshore drilling programs throughout the U.S. Gulf of Mexico, Brazil, East and West Africa and Asia.

At the recent price of $45.74, TDW is trading for 0.92x book value vs. its historic norm of 1.5x book. Based on improving fundamentals and with its favorable valuation metrics, we expect TDW to generate an above-average market return in coming years. Management believes the company has earnings power of $8 to $10 per share in the coming upcycle. The stock has historically traded for 10x-plus earnings and offers significant upside. (Initially recommended at higher prices in early April).

Valero Energy (VLO), a leading independent refining company, reported a modest earnings beat of 31 cents per share in early May. VLO is expected to earn $3.70 per share in 2012 on solid refining spreads. At its recent price of $21.88, VLO trades for just 5.9x 2012's earnings and 0.76x book vs. a historical 10-year average of 1.22. The company also provides investors with a 2.7% dividend yield while they wait.

With continued improving fundamentals and its favorable valuation, VLO should provide investors with an above-average market return in the coming year. The company is well positioned to benefit from the increased complexity of refining heavy crude oils, cheap natural gas feedstocks and the increased supply of low cost crude oils from the emerging U.S. and Canadian shale plays. 

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