The Cheapest Energy Stocks on the Market

David Sterman's picture

Tuesday, January 29, 2013 - 2:30am

by David Sterman

With every passing month, we read another report about our nation's fast-track path to energy independence. Our domestic production of oil and gas is growing so rapidly, that we may just be a half-decade away from ending our long addiction to imported energy. And this would be great news for our nation's trade deficit, employment picture and national security.

Despite the ever-brightening energy picture, it's still quite easy to find value-priced stocks in this sector. Dozens of stocks trade at reasonable levels in relation to their cash flow, asset base and long-term growth prospects. I ran a series of screens to help bring a sharper focus to these industry value plays. 

By triangulating the results of several screens, it's possible to see the deepest values in this steadily-growing sector.

Single-digit multiples abound
While stocks in many other industries are often assessed by their price-to-earnings (P/E) multiples, this metric isn't quite as useful for energy-exploration firms. They have such intense capital requirements and high levels of depreciation and amortization to write down their capital expenses, that net profits can be misleading. Instead, cash flow is the more salient metric.

I looked at all of the oil and gas drillers that are either headquartered in the United States, or trade on U.S. stock exchanges through American depositary receipts, with a market value of at least $500 million. I found 60 that trade for less than six times trailing cash flow.

To narrow down the list, I only focused on companies that trade for less than 1.25 times book value. This means these companies have solid underlying support, trading near or below the value of their base of assets. The list was narrowed down to 16 stocks, as you can see below.

The Cheapest Energy Stocks I've Found 

A pair of energy producers that have exposure to Argentina (YPF S.A. (NYSE: YPF) and Petrobras Argentina (NYSE: PZE)) have been eliminated from this group because these companies now face a risky operating environment thanks to recent government policy changes. Still, it's noteworthy that some of the energy producers (in terms of price) hail from countries such as Russia (Lukoil), Italy (Eni), France (TOTAL) and the U.K. (BP). Sometimes, as Elliott Gue, chief strategist of StreetAuthority's High-Yield International newsletter, can attest, you need to venture abroad to find an industry's top bargains.

Taking the group of stocks above, let's look at what would happen if we first focus on price-to-book-value measures, and secondarily at price-to-cash flow. Here's the revised ranking.

Notably, these foreign oil producers don't stack up as well, as they mostly trade above book value. I dug deeper into this group, focusing only on the eight stocks that trade for book value -- or less -- and that trade for less than six times trailing cash flow. Two stocks stand out as especially appealing...

1. WPX Energy (NYSE: WPX)
This company mostly focuses on the production of natural gas, so its appeal depends on your interest in this energy source relative to crude oil. (We happen to think natural gas has a lot of potential. To find out why, click here.)

Thanks to the sharp drop in gas prices during the past few years, management has throttled back output to restrain capital spending. Still, even with low gas prices, the company's strong positioning in the Piceance Basin in northwest Colorado, where its drilling costs are quite low, is setting the stage for solid cash flow in the years ahead.

On the upcoming fourth-quarter conference call, management is expected to discuss a sharp rise in output that began in the fourth quarter, coupled with more than $200 million in annualized cost reductions. WPX expects to generate more than $1 billion in EBITDAX in 2013, which would be the strongest since the boom years of 2008.

Looking beyond cash flow, this is a very cheap stock in terms of the assets in place. The company sports about $5.4 billion in tangible book value, but is valued by the market at less than $3 billion.

2. Bill Barrett (NYSE: BBG)
This company is shaping up to be an interesting turnaround play, or it may simply just become buyout fodder. The energy-exploration firm just lost its two top executives (including the son of the company's founder) as shareholders chafe at a poor track record. Indeed, this stock has been on a losing streak for two years. 

Several years of missed financial targets have apparently led to a rift between management and the board, which is now seeking out fresh blood.

Analysts expect the new management team to reduce the company's focus on new projects and squeeze more cash flow out of existing projects. EBITDA has been stuck at about $400 million in each of the past four years, even as production volume and revenue have risen. That's not a good sign. 

If the new management's likely greater emphasis on cash flow yields results, then this stock will begin to look quite cheap based on that metric. If not, then larger players in the industry may seize the initiative and make a buyout offer as the company has $1.17 billion in tangible assets, but a current market value of less than $800 million.

Risks to Consider: Energy prices are a big factor in industry stock price performance. These stocks look attractively-priced relative to the peer group, but would fail to rally if energy prices slump.

Action to Take --> These stocks represent solid value by a pair of metrics. In light of the North American energy boom, they offer the prospect of solid growth in tandem with that value proposition.

Of the two stocks profiled here, WPX Energy provides a fairly low-risk path to share price gains, as management needs to simply deliver on the announced cost cuts and production increases. Bill Barrett is more speculative, but could offer fairly significant upside if reduced capital spending leads to robust free cash flow. The fact that both of these stocks trade well below tangible book value means they provide meaningful downside support.

P.S. -- The abundance of natural gas in the United States could lead to a third industrial revolution. One analyst is predicting a stock could rise $1,566%. Another stock has already jumped more than 1,000% and is expected to keep going. To learn more about investing in the natural gas boom, click here.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.