Energy 'Pariahs' Signal Opportunities

 | Dec 17, 2013 | 10:00 AM EST  | Comments
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Stock quotes in this article:

ge

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xom

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msft

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tsla

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nflx

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bp

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bbry

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line

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bry

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rig

During decades of investing I have come to myriad conclusions about investors. First, it is generally a straight forward and easy decision for investors to put money into blue chips like General Electric (GE), ExxonMobil (XOM) or Microsoft (MSFT). It also seems easier than it should be to succumb into putting funds into highflying momentum stocks of the day such as Tesla Motors (TSLA) or Netflix (NFLX) when they are running up.

What seems to be more difficult is to go against the herd and invest in equities where sentiment is currently dismal. What I have also found over the long term, however, is that investing in these 'pariahs' has reaped some of the best gains for my portfolio over time.

The trick is finding equities whose prospects are just temporarily under distress and avoid value traps whose business models are in permanent decline such as Blackberry (BBRY). There are several of these pariahs currently residing in the energy sector that look attractive on a long term basis.

It is hard to discuss pariahs among energy concerns without mentioning BP plc. (BP); formerly known as British Petroleum. It is also tough to do a better job than Daniel Dicker did the other day discussing the prospects for the energy giant and why it is his "Top E&P Pick for 2014".

BP has the majority of its litigation woes behind it and should now be able to catch up to some of big runs its major integrated oil competitors have seen in their stocks over the past few years. The shares also yield almost five percent and also are priced at less than 9x forward earnings.

Another energy concern that had a challenging 2013 is limited partnership oil and gas producer Linn Energy (LINE). The company has been the focus of several negative articles in Barron's questioning some of its accounting practices this year. Despite speculation, this has not resulted in any regulatory actions and these practices are standard in the industry.

The company's shareholders just approved its merger with Berry Petroleum (BRY) which was temporarily delayed by these 'hit' pieces. This merger will boost the company's growth, production and reserves. Linn also issued solid production guidance last week.

Linn boasts prime acreage in the Permian and other shale plays. Its production growth is also largely coming from increased output in oil. The shares provide a distribution yield north of 10% and I look for Linn to make up for its underperformance in 2013 in the New Year.

Finally, the stock of Transocean (RIG) has not done much in 2013 but looks attractive here. The energy services provider was also implicated in the Macondo disaster in the Gulf in 2010 and also was part of a suit by the Brazilian government for a minor spill off the coast of Brazil during this year. Ramifications from both incidents are almost all behind it now.

The company has an almost $30 billion order backlog and is being pushed by Carl Icahn to pursue a master limited partnership structure which should come public in mid-2014. Mr. Icahn was also successful in getting Transocean to issue a special dividend of $3 a share. The stock provides a normal dividend yield of 4.6%.

The company is on a significant margin improvement plan and should also benefit from Mexico recently lifting restrictions on its oil industry and by the continued trend of increasing demand for deep offshore drilling. Revenue growth should accelerate next year into the low double digits and the shares are cheap at around 8.5x forward earnings.

Investing in what others are avoiding is not an easy dig as it goes against basic human nature. However, I have found bucking the trend usually yields good results over time. 

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