The energy sector makes up 18% of our equal-weighted buy list, versus 6% for the S&P SmallCap 600 Index and 11% for the broader S&P 1500 Index.
Energy investors will need to be increasingly selective going forward, and subscribers should never let a single sector dominate their portfolios. But we remain comfortable overweighting the sector, for at least four reasons:
1) Based on Quadrix, there is no shortage of attractive energy stocks. Of the 695 U.S. stocks with overall scores above 80 along with value, earnings estimates and performance scores above 20 (our initial screen for new recommendations), 92 are energy stocks.
2) High prices for oil and natural gas are fueling robust cash flows for energy producers. Cash provided by operations, found on the statement of cash flow, is the lifeblood of capital-intensive energy firms. For oil and gas producers and integrated oil companies in the S&P 1500 Index, cash flow has grown nearly 24% annually over the last three years.
3) Accelerating cash flow is translating into capital spending. Capital expenditures for the S&P 1500 oil and gas producers and integrated oils reached $102 billion for the 12 months ended March, up 21% from a year earlier. Over the last three years, spending on capital expenditures has grown at an impressive 28% annual clip. Even if oil and gas prices drop sharply, which seems unlikely given supply and demand forecasts, capital spending should remain robust.
4) Shares of energy companies, especially equipment and services concerns, seem unduly cheap given well-defined growth prospects, even if per-barrel oil prices retreat by $10 or $15. The average energy stock in the S&P 1500 trades at 17 times estimated current-year earnings and 14 times next-year earnings. Yet profits, on average, are expected to increase 17% this year and 21% next year. As a group, energy stocks have seen aggressive upward revisions to profit estimates in recent quarters.
The three names reviewed below represent attractive values.
Gardner Denver is a leading maker of industrial pumps and compressors and one of the largest providers of reciprocating pumps used in oil and gas drilling, servicing and production. The company's products are also used in medical, packaging and laboratory equipment. June-quarter earnings per share reached $0.83, up 34% but a penny below the consensus. Revenue rose 10%, keyed by a 16% increase in fluid-transfer products. Internal revenue growth was a healthy 6%. The order backlog rose nearly 7%.
For full-year 2007, management lifted its per-share profit guidance to a range of $3.10 to $3.18, up from the $2.49 earned in 2006. Gardner Denver, positioned to exceed consensus profit estimates, is a best buy.
NATCO makes products that help filter impurities from oil and gas. NATCO services both onshore and offshore fields in most major producing regions. Robust exploration and production spending by customers, coupled with the declining quality of reserves, should sustain strong demand for filtration equipment. For 2008, Wall Street expects per-share earnings of $2.47 this year and $3.02 in 2008.
Considering NATCO's growth prospects, debt-free balance sheet and cash of $2.50 per share, the stock seems undervalued at 18 times estimated year-ahead earnings of $2.67. NATCO, with an overall Quadrix score of 94, is being upgraded to best buy.
Tidewater owns 455 ships, which make up the world's largest fleet serving the offshore energy industry. The company supports all phases of offshore exploration, development and production. Services include towing and anchoring, pipe laying and seismic work. Tidewater earned $1.61 in the June quarter, up 31% but 3 cents below consensus expectations. Revenue increased 13%. Tidewater's worldwide fleet utilization was a healthy 78%, while the average vessel day rate rose 15%.
Despite the June-quarter shortfall, consensus profit estimates for Tidewater have trended higher over the last month and now project per-share growth of 16% this year and 9% next year. Tidewater, trading at a reasonable nine times estimated year-ahead earnings of $7.21 per share, is rated "buy."
For six more investing ideas in the energy sector, click on the slide show link below.
by David Wright
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