Grab This Misguided Discount in Oil and Gas

 | Sep 03, 2013 | 1:00 PM EDT
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We've seen some signs lately that the global economy is struggling its way to a recovery. In recent weeks we've witnessed better, if not fantastic, news out of Europe that seems to indicate things have at least stopped getting worse in the Old World. Manufacturing is growing, albeit at a snail's pace; unemployment has improved slightly; and purchasing managers have expressed more confidence in the future. Over the weekend, Central European factories reported that both output and demand were up in August. The European Commission expects the region to exit the recession in the fourth quarter of this year, and to actually grow a little in 2014.

Meanwhile, I am uber-skeptical of everything that comes from China, but the nation appears to be back on a growth path after a slowdown for a couple of quarters. China's version of the purchasing managers index improved in August, as did the PMI kept by HSBC. J.P. Morgan and Deutsche Bank both raised their growth-rate estimates for the world's largest emerging market. Even Japan is getting in on the recovery scenario, having put in improving economic numbers over the past few weeks.

Last week, I wrote about using the large international banks as a way to play a nascent global recovery. Over the weekend I spent some time thinking about other ways to get in on a long, slow recovery in Europe and Asia. I looked around for some companies that had been able to grow the value of their enterprise over the very difficult past decade, and which might be positioned for further and even accelerated growth as conditions improve around the world.

I specifically looked for companies that had shown strong book-value growth over the past 10 years, and which operate in industries that should grow at a faster pace than that of the global economy. I then filtered these stocks using Benjamin Graham's growth stock formula by multiplying the price-to-book-value ratio by the price-to-earnings ratio. Only stocks with a resulting sum of 22.5 or less were considered cheap enough to purchase.

The first thing that's very apparent is that the global markets are ignoring carbon fuels much in the manner that the U.S. market has done over the past few years. While I realize the alternative-energy story is a lot sexier, the truth is that it's also quite false at this moment. It is also false that long-term demand for fossil fuels will be declining any time soon. Oil and gas will continue to be the fuels that meet most global energy needs, and the companies that find and produce the stuff are going to grow more quickly than will the global economy.

I have written several times about Petrobras (PBR), the large Brazilian oil-and-gas concern. The company has some issues with government control and the weak economic situation in its home country, but I am confident these will sort themselves out over time. The company has ambitious spending plans to increase production, and it has said it will spend $22 billion annually on development and $5 billion on exploration.

Petrobras is also selling what it considers to be non-core assets, thus helping itself meet its capital-expenditure needs without the need to issue any new equity. Multiplying the P/E ratio by the P/B ratio gives us a result of just 5.2, so this stock certainly qualifies as cheap. On average, book value has grown annually by more than 25% over the past decade, so Petrobras has definitely been a growth company. I think it will become one again, particularly once the political and economic situation its home country settles down.

Ensco (ESV) has been a great stock for me, as I bought it at a large discount to tangible book value back in 2008. Although the shares now trade at a premium to tangible book value, they are still incredibly cheap when you consider this company's growth prospects.

Ensco, a provider of contract offshore-drilling services, has done everything right for the past decade. Book value has grown by an average rate of almost 14%, and the firm is expanding its fleet to offshore rigs. More expansion is planned going forward, and demand should be rising more than quickly enough for the rigs to be put into service almost immediately. Ensco has one of the largest ultra deepwater fleets in the world, and this should be the fastest-growing segment of the exploration-and-production industry over the next decade.

Ensco's P/E multiplied by the P/B is just 15, so it still qualifies as a cheap growth stock. Over the past decade, book value has increased in every year except for one, and that year was just flat. This has the potential to be one of those companies for which price never catches up to value, and which ultimately becomes a huge winner.

I am surprised by the discount that's being applied to oil-and-gas companies around the world. Demand will go up, and so will the profit earned by these companies for the foreseeable future. Growth and value investors alike should be considering adding energy to their long-term portfolios.

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