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Wednesday, August 01, 2012

Voo-doo and Oil

I have talked on several occasions of late about energy stocks being one of the few truly cheap sectors of the stock market. In addition to the large drop in natural gas that has gotten all the headlines oil prices weakened in the second quarter as well. Oil initially declined by roughly 28% before rebounding in the past few weeks.  Oil prices on the New York exchanges are still roughly 20% off the highs for the year. Performance for the exploration and production companies, as well as oil service stocks has followed pretty much the same track as the commodities. The price weakness has sent me scouring the oil sector for ideas and we have come up with a few so far.

It is no secret that I make my stock selections based on underlying asset value. I do not usually pay a lot of attention to PE ratios or analyst forecasts.  I find them to be unreliable indicators of absolute value and pretty much ignore them. This doesn’t mean they are wrong or can’t be used in some form to pick stocks. It means that as I rule I do not use them. I try to be pretty open minded  so when I received an email from the Voo-Doo Prof with some earnings growth compared to PE stock picks I looked a little deeper.

Profess Mark McNabb is the Director of the M.S in Finance at UT-Dallas and is a very astute investor and observer of markets. He recently had his class put together a spreadsheet of energy related stocks with PE ratios under 11 and expected earnings growth over the next two years of greater than 10%. The spreadsheet had some interesting names with strong price appreciation potential so I begged the good professor’s permission to share with readers. He kindly agreed.

A few of the names will be familiar. Hess Oil (HES) is one of my favorite energy picks and with a current PE of 7 and expected growth of almost 11% the company makes the cut. Nabors Industries (NBR) is a favorite pick in the group and also makes the list of potential undervalued energy growth names with a PE ratio of one third the expected growth rate. Both stocks also trade below tangible book value and are considered too cheap not to own at current levels.

Some of the more intriguing names are those that might never hit my normal screens. Matador Holdings (MTDR)is an oil and gas company that focuses on exploration and production in the unconventional US fields. Their primary operations are in the eagle Ford and Haynesville fields. Like many companies in the unconventional fields they have been switching focus from natural gas to oil and liquids. Matador seems to be achieving that goal quicker than many of their competitors. Capital expenditures for 2012 will be 94% focused on oil and liquids operations and oil production is expected to rises by 10 fold year –over year. So far they are on track to meet their goals. Earnings are expected to grow by 179% annually but the current price to earnings ratio is just 8.2. If they come anywhere close to the estimates the stock is extraordinarily cheap candidate for growth investors.

Global Geophysical (GGS) is another stock that probably doesn’t’ make my usual lists but may be very attractive to growth investors. The company provides seismic data to the oil and gas industry and has shown consistent growth. Over the past five years revenues have been growing by 35% while earnings compounded by 14% annually. For the next few years earnings are expected to explode by more than 100% and the stock trades at just 6 times earnings. The stocks also trades for less than 3 times free cash flow and has an EV/Ebitda ratio of just 2.5 so it is cheap on several earnings metrics. Insiders own 44% of the shares and at least one has been a buyer in recent weeks. The stock is down more than 60% over the past year but could surge higher as oil prices improve over the next two years.

Keeping an open mind is critical for long term success. When someone with a long record of success and strong idea generation like Dr. McNabb suggest a strategy investors should give it due consideration.

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