Inside Wall Street: Where to Bet on the Resurgence in Energy Stocks

Oil well pump
Oil well pump

The Egyptian crisis has predictably stirred up energy stocks, which are once again on the rise and helping power the stock market's recent strength. While the unrest in Egypt has been the latest catalyst behind the group's advance, better-than-expected quarterly results posted by oil giants ExxonMobil (XOM), Chevron (CVX) and ConocoPhillips (COP) also helped energize the oil-patch stocks. The group for the most part had been a laggard before then.

With Brent crude oil prices again hitting higher -- breaking through the $100 a barrel level this week -- the question now is: How high they will go from here? But regardless of whether oil prices remain sharply volatile, energy stocks deserve high priority in investor portfolios, argue some investment pros.

The Attraction of Oil Service Stocks

Stocks representing various subsectors of the industry can still be counted on for long-term returns, according to industry analysts John Keller and Michael Marino of investment bank Stephens. They focus mainly on the small- to mid-cap stocks that they believe offer more value opportunities and where growth could be robust. The analysts look for little-known companies with specific catalysts, such as valuable hidden assets or restructuring prospects. The oil-service stocks, they figure, are where you'll find such attractive situations.

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In that group, Keller and Marino are betting on Helix Energy Solutions (HLX), a Houston-based provider of deepwater construction and maintenance services to the U.S. offshore energy industry. Helix also operates an exploration and production (E&P) unit. One particular appeal of Helix: It's in the midst of a restructuring. It has put up for sale its E&P operations. Helix's E&P assets are worth about $700 million to $900 million, according to Marino.

Its other unit, comprising marine assets -- including a fleet of vessels, barges and remotely operated vehicles -- are worth $2 billion, figures the analyst. With the likely sale of the E&P properties, Helix could evolve into a pure-play service company, and the full value of the marine business would then be recognized.

That's part of the reason why Helix's shares have been on the rise, climbing from a 52-week low of $8.38 on Aug. 25, 2010, to $12.54 on Feb. 1. The Stephens analysts rate Helix as overweight, with a 12-month target of $17.

Global Trends and Cycles

Also a big bull on energy is James Dailey, lead portfolio manager at TEAM Asset Strategy Fund (TEAMX). "Well conceived energy plays are a way to bag big gains over the long haul as the U.S. and global economic recovery continues to accelerate," he says. The long-term bull market for commodities, including oil and natural gas, remains intact and bodes well for energy stocks, notes Dailey.

Part of TEAM's strategy is identifying global trends and economic cycles, and using fundamental, technical and quantitative analyses in selecting stocks or assets that are best positioned to benefit, explains Dailey.

In the current environment, Dailey's top three choices in the oil patch are:

  • Petrobras or Petroleo Brasileiro (PBR), a large integrated petroleum company operating in Brazil and other parts of South America. It's American Depositary Receipts (ADRs), which hit a 52-week high of $47.39 in mid-March 2010, dropped to a low of 31 in October 2010, but then rallied to $37 by Feb. 1.

  • Chesapeake Energy (CHK), the largest independent exploration and production company in the U.S., focused largely on building onshore natural-gas reserves. Its stock, now at about $30 a share, has jumped to a 52-week high.

  • EnCana (ECA), one of North America's leading independent natural-gas explorers and producers, trading at $32 a share, down from its 52-week high of $35.25. Dailey figures the stock could exceed its high in a year.

Part of Petrobras's sharp drop was due to its large $70 billion financing it had to do to pay the Brazilian government for rights to explore and develop up to 5 billion barrels of oil equivalents in certain offshore regions. Petrobras agreed to pay more than $42 billion, or about $8.50 per barrel of oil equivalents, for those rights. One of the world's largest oil-and-gas companies and Brazil's national petroleum company, Petrobras went public in 2000, but it's still majority owned by the Brazilian government. Its ADRs trade on the New York Stock Exchange.

Dailey figures the stock should climb to $50, based largely on rising oil prices and its increasing oil-and-gas production. Petrobras' average oil output in Brazil jumped to a record volume, in December, to 2.21 million barrels a day, surpassing the previous record of 2.02 million set in April 2010. Including its natural gas output, Petrobras' total production in Brazil climbed to 2.49 million barrels in December 2010 -- a monthly record -- up nearly 8% from the total output in December 2009.

A Takeover or Merger Candidate?

Chesapeake, on the other hand, is a perfect play on natural gas, says Dailey. It combines the appeal of a possible takeover deal with its rich assets, which have made Chesapeake the largest producer of natural gas in the U.S. Activist investor Carl Icahn owns some 5.5% of the stock, prompting some investors to assume that Chesapeake could become a takeover or merger candidate. Its big stakeholders are led by Southeast Asset Management, which owns a 12.4% stake.

Dailey sees the stock rising to the mid-$30s this year, based on its aggressive acquisition strategy and continued sale of certain assets. In October 2010, Chesapeake signed a joint venture with China's large energy enterprise, CNOOC. The Chinese company agreed to buy a 33.3% stake in Chesapeake's oil and gas leasehold in the Eagle Ford Shale for $1.08 billion. CNOOC also agreed to fund 75% of Chesapeake's share of drilling and completion costs in the Eagle Ford Shale project.

In short, the sun is again shining on the oil patch. As the oil-and-gas group continues to reenergize, Wall Street is bound to once more pay heed to the huge growth potential of the energy stocks -- and recapture the attention of investors.