Energy Space Still Brimming With Value

 | Nov 14, 2013 | 12:00 PM EST
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Since I began writing these columns in early 2012, my own portfolio has been overweight the energy sector. This group has given me some of the biggest contributors to my overall performance, as well as provided fodder for a good portion of my topics in these pages.

Even despite some huge runs in some of my core positions in this area, I continue to be overweight the sector. Domestic energy production, after all, continues to grow unabated. Valuations are still reasonable as well and, as a result, I continue to find good bargains in this space.

Another thing I like about the sector is that transactions within it tend to be shareholder-friendly. I don't see some of the value-destroying acquisitions that sometime take place when the overall market is near all-time highs.

Other than Exxon Mobil's (XOM) $40 billion acquisition of XTO Energy in 2010 near the height of natural gas prices, the industry has been very focused on creating shareholder value. Mid-majors have sold off noncore and overseas assets in order to put more capital into growing North American production, majors have spun out refinery assets and the industry overall has been very receptive to listening to activist fund managers and unlocking value for their shareholders.

The transactions that are being made in the sector have tended to be accretive, strategic and shareholder-friendly -- as is particularly illustrated by two deals announced this week.

The other day, for instance, Western Refining (WNR) said it is acquiring almost 40% of refining limited partnership Northern Tier Energy (NTI), as well as 100% of its general partner.

This transaction provides several benefits to Western Refining. It gives the company direct access to cost-advantaged Bakken and Canadian crude oils, and it also adds scale to its business and diversifies operations by adding a new geographic region to its refining platform.

In addition, this move also gives Western an avenue to spin off its existing refineries into a master limited partner (MLP) structure. This could unlock significant shareholder value. Refinery MLPs like CVR Refining (CVRR) sell at much higher multiples vs. Western and other refining stocks when it comes to enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA).

Both Goldman Sachs and UBS have come out with positive comments on this transaction. In fact, as a result of this deal, UBS has moved its Western price target to $41 a share from $34.

As I have noted several times recently on Columnist Conversations, the refinery sector is starting to outperform the overall market again after having posted a dismal six months. Western was already a good value before this transaction. The stock sells at just over 7x trailing earnings, has a solid balance sheet and sports a dividend yield of 2.7%. This deal just provides another positive catalyst for unlocking more value for Western's shareholders.

In a similar move Crosstex Energy (XTEX), which is a limited partnership, announced a deal whereby it will combine its midstream assets with those of Devon Energy (DVN) in order to create a new MLP. I have commented on how this deal makes sense for Devon Energy. Devon's management believes this transaction will result in $700 million in annual earnings within the partnership vs. the $425 million it had estimated a standalone MLP would have generated.

The deal also makes sense for Crosstex. The partnership will create a new company with diversification and scale, along with an enhanced liquids-oriented growth profile. RBC Capital has upgraded Crosstex to an Outperform as a result of this new combination. R.W. Baird has called the transaction "an epic deal."

Crosstex already had a solid revenue growth profile, and it provides a distribution yield of more than 5%. Earnings estimates for 2014 have begun to rise as a result of this combination, and the partnership should continue to reward shareholders.

These types of strategic transactions are among the core reasons I continue to have confidence in the long-term future of the energy sector, and why I will continue to overweight it within my portfolio.\

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