With Energy Sector Risk Declining, 14 Potential Buy Candidates

Alan Brochstein revisits the long-term potential of energy stocks

A few weeks ago, I expressed caution on the energy sector and shared a list of potential sell candidates despite my longer-term bullishness for the group (13 Potential Energy-Stock Sell Candidates).  The pullback I expected materialized, and it looks like it may have fully played out - several of the names I mentioned having declined dramatically.

With the shake-out most likely behind us, I wanted to screen with the intent of looking for names to consider buying.  As before, I screened on the Russell 3000, which includes 178 energy stocks.

While energy's long-term outlook seems positive, with new technologies enabling better recovery and aiding in finding new supplies, investors have piled into the stocks. For the year, energy stocks in the S&P 500 are up an aggregate of 16.5%, which is twice as much as the overall market. In the S&P 600 Small-Cap, the performance of energy stocks is even stronger at + 21.2%. Of course, a lot of the interest is driven by the surge in oil prices, which has increased over 20% since the end of the year. There’s not a direct correlation, though, between the underlying price of the commodity and the stocks of those companies that either own reserves or provide goods and services associated with the production of them. Between labor constraints, other production constraints, rising material costs, the potential for taxation (like in the North Sea recently) and many other profit inhibitors, earnings growth may not keep up with expectations.

I decided to screen for stocks in the sector (in the Russell 3000) that might be offering a good entry now.  Here is what I did:

·         2012 Projected EPS Growth > 10%

We started with 501 energy names, 264 of which are >$1 billion in market cap. Here are the 14 that made this first cut:

[click the image above to enlarge it]

Only 2 of the companies (their tickers are highlighted) made the potential sell list previously as well as this potential buy list. As a reminder, this screen is for illustrative purposes only and doesn’t constitute a recommendation. While I am familiar with several of these companies, I haven’t thoroughly investigated the vast majority - and you should always do your own research and due diligence before investing.

The list has a median year-to-date return of 21%, so these are definitely doing better than the market despite their recent pullbacks. A few of them are up less than 10%. As you can see, the median decline in May has been 14%, with the worst being 21%. Since my previous post on energy stocks, Helix (HLX) has declined from 18.09 to 15.51, while SM Energy (SM) has dropped from 74.76 to 62.64. Almost all of the stocks are now trading below their 50-day average price, but they remain sharply above their longer-term (200-day) average. Analysts are hiking the earnings estimates rather sharply for 2011 (25% median) and the typical stock that made the cut is expected to grow EPS by 34% next year.

I will leave the further digging to you, but I do want to share my perspective on two names. First, I own Comstock Resources (CRK) in my Top 20 Model Portfolio and added to it very recently after the pullback. The company is a natural gas producer focused on the Haynesville and the Eagle Ford. Management has shown itself to be shrewd over the past several years and has remained true to fellow shareholders by not issuing any equity. The reason I like it is that their production growth looks strong, and I believe that natural gas prices will be stable.  Profits have the potential to soar if they continue to reduce their production costs.

Oil States (OIS) is a highly diversified company with a sharp lady running it. The company recently expanded with an acquisition that makes providing lodging to workers its largest business by far. I believe that the company is well-positioned to benefit from the energy cycle on many fronts, and I find the valuation very attractive.

While I was previously cautious on energy, especially smaller names,  due to many of the stocks being overbought with too much positive sentiment, it now looks like a good time to consider increasing exposure. The screen I shared is designed to identify companies that may offer a good entry after the correction. As always, screens like this are just a starting point, so be sure to do your own research.

Regards,

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  Alan Brochstein is long CRK in model portfolios at Invest By Model at this writing.

Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs. 

Alan Brochstein maintains a business relationship with TradeKing.