Riding the North American Energy Boom

 | Oct 25, 2013 | 12:00 PM EDT
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We have spent this week speaking about how critical sector weighting is to overall portfolio performance. I have spent my three columns this week discussing the reasons I am underweight a couple of sectors (financials and consumer discretionary) and why I find industrials attractive over the next few months.

Today I'll explain why I continue to be overweight the energy sector, even though it has already provided outsized gains in my portfolio this year. Like manufacturing, which was yesterday's focus, this sector is one of the few bright spots in an otherwise tepid economic recovery.

The country has moved from a declining energy producer five or six years ago to the leading energy producer in the world -- if you include natural gas production. This huge surge in domestic energy production has myriad implications.

It makes our industries more competitive, as they enjoy the lowest energy costs in the developed world. Obviously, this development has significant geopolitical ramifications as the U.S. is becoming less dependent on energy sources in less stable and savory parts of the world.

This boom has also been responsible for a good portion of the anemic job growth over the past five years, especially in the high wage employment areas. This production surge has finally rewarded investors in this sector very well over the past half-decade.

I still believe we are in the early innings of this game changing shift. Technology continues to improve, infrastructure is still being built out (pipelines, storage facilities, gas processing plants, etc.) and there are shale regions in the country that have barely been touched yet by this new technology.

Given this outlook, the sector is one of the most heavily weighted in my portfolio and I anticipate that this strategy will continue to produce rewards. I am maintaining a variety of investments across the various sub-sectors of the overall industry.

I have more than doubled my money over the past year in a couple of small exploration-and-production (E&P) concerns, Synergy Resources (SYRG) and Triangle Petroleum (TPLM). I like Abraxas Petroleum (AXAS) in the same vein. It is a small producer with acreage in most of the core shale producing regions in the U.S.

The company is experiencing rapid production growth, insiders have been net buyers of the stock over the past six months and earnings are predicted to double in fiscal 2014. The stock is also cheap, trading at just over 10x forward earnings.

A bigger producer I like is Devon Energy (DVN). The company has lots of opportunities to get more focused on concentrating on growing production from its most promising properties. It reminds me a bit of where Hess (HES) was earlier in the year before activists forced changes that have made its stock a huge winner in 2013.

Devon recently took the first step in this process by announcing it would combine its midstream assets with partner Crosstex and form a master limited partnership (MLP). The company believes this transaction will result in getting $700 million in annual earnings from these assets, significantly above the current $425 million in profits that it would receive as a stand-alone MLP.

This will allow the company to focus on growing its production of oil and gas that was already increasing to the low double digits. Analysts have been very positive on this move and a rash of price target upward revisions have flowed over Devon since the deal was announced. This could be just the first in many shareholder friendly moves. The stock sells for less than 12x forward earnings.

Finally, after months of being underweight refiners, I am starting to get more bullish on the sector. After reaching parity, WTI & Brent have diverged again to almost a $10 a barrel spread. I like the biggest North American refinery company in this space, Valero Energy (VLO).

The company's assets are well positioned on the Gulf Coast to take advantage of the huge oil production boom in Texas and the mid-continent. It is also getting more and more of its revenues from shipping refined products overseas where it can make higher margins. The shares trade for less than 8x trailing earnings and they also yield 2.3%.

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we like this chart here, it appears ready to move higher. BOUGHT BZUN OCT 35 CALL AT 3.40
Large-cap, high-quality McKesson (MCK) is too cheap now, at $147.51 or so. The stock hit $243.60 more than 2.5...



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