Bombardier (TSX: BBD.B, OTC: BBRDF). Bombardier has not performed well since I recommended it in October 2009 at $5.03. But the company recently unveiled a fresh strategy with the potential to add between $10 and $15 billion of incremental revenues over the medium term. The most encouraging aspect of this new plan is that corporate growth is evenly balanced between aircraft sales and further penetration of a robust rail market in Europe and the emerging nations.
The stock is oversold at C$4.16 and could move up significantly as investors recognize that earnings are likely to exceed US$0.50 a share by 2013.
Norfolk Southern Corporation (NYSE: NSC). Railway business continues to improve despite the economic slowdown. Norfolk Southern is profiting, generating strong earnings growth spurred by improved pricing and ramped-up equipment resources. The company's main railway network in the eastern U.S. is benefitting from a resurgent auto industry and highly profitable coal shipments to utilities and the export markets. Operating margins are widening.
I originally recommended the stock in December 2009 at US$52.22. It closed on Friday at US$75.31 so we already have a gain of 44%. I think there is more to come and that Norfolk Southern has significant upside potential.
Peabody Energy (NYSE: BTU). Peabody's shares have been under pressure recently because of the company's US$5 billion bid for Australia's Macarthur Coal. Investors are worried that there is going to be a dilutive stock issue to finance the deal. I think that concern is more than fully reflected in the US$35.99 share price. In fact, Peabody, which is the world's largest private coal company, plans to fund the acquisition with cash and manageable debt.
I picked this stock for the IWB in August 2011 at US$48.23. It has retreated a lot since then and at these levels BTU is excellent value. The shares could move up significantly when the market is reassured about Macarthur.
Talisman Energy (TSX, NYSE: TLM). This stock is not on our Recommended List so I am adding it now. Priced at C$12.68, US$12.36, I think it offers an excellent investment opportunity.
The shares have been badly battered because of lowered guidance resulting from project delays and extended maintenance. As usual in a nervous market, the selling has been overdone. The company is expected to report cash flow of US$3.25 a share in 2012. So you are only paying a 3.7 cash multiple for a major oil producer with a net asset value of US$29. I expect Talisman to outperform its peers and the market this year. An exploration success would be a bonus.
Background on Talisman
Obviously, these are very difficult markets. The important thing, though, is to remain positive and to focus on the fundamentals. The coming year is going to be, at least to some extent, a replay of 2011 as we continue to bump along the bottom of a financial contraction and live through a massive deleveraging as debt is paid down. So we should look for some guidance from the last 12 months.
For example, oil prices remained surprisingly firm last year while other commodities soared, then plummeted. We could see a similar pattern. As a matter of fact, I think that oil prices could move higher in 2012 and give energy stocks a boost.
The situation is this. All of the firm data available points to rising oil prices through most of 2012. Inventories are low and there is little spare capacity. Iranian production, which accounts for 5% of global output, is rapidly becoming a question mark. Moreover, in the unlikely event that overall demand for energy eases, the major Middle Eastern producers are bound to adjust their supply to keep oil at close to US$100 a barrel. Almost unnoticed amidst all the recent financial chaos, Saudi Arabia, the largest oil producer has been increasing its "break even" price, the level it needs to meet massive government spending, to US$90/b in 2012. Any dip below that price is likely to be brief.
I could go on but suffice to say that there is a compelling case for high oil prices regardless of any economic downturns. Goldman Sachs expects to see US$120 a barrel by July. Barclays Capital is looking for US$115 during the next few months. As a result, I think that the major Canadian producers are going to do better than expected this year. Most forecasts by the Bay Street analysts seem to be based on US$95 oil.
We need to tread cautiously, however, and stay with the senior, proven players. It's also a good idea to steer clear of the oil sands producers for now. A growing protest about this type of production is bound to hamper the stocks.
Talisman Energy fits the bill nicely. Originally a spin-off from British Petroleum, TLM is one of Canada's largest oil and gas exploration and production companies. Its diversified portfolio of assets is mainly concentrated in Canada, the U.S., the North Sea, and Southeast Asia. Market capital exceeds $16 billion and production of 417,000 barrels of oil equivalent per day (boe/d) in 2010 generated a cash flow of $2.81 per share (all dollar amounts are in U.S. currency). Output was 50% oil and 50% gas.
In 2011 the company was plagued by prolonged maintenance shutdowns in the North Sea and slower than expected U.S. shale gas production. As a result, management is reducing exposure to the North Sea and selling some North American gas operations. On the plus side, Asian output is growing rapidly and provided $200 million in free cash flow in 2010. Looking ahead, overall production is expected to be 422,000 boe/d when the final results for 2011 come out and increase to about 470,000 boe/d this year.
My feeling is that investors were disappointed by the recent technical problems but overreacted. The shares are cheap, the company's production mix is improving, and oil prices are expected to rise. That makes the stock, yielding 2.2% at Friday closing price of C$12.68, US$12.36 a relatively defensive investment with an excellent risk/return ratio.
Action now: Talisman is a Buy with a target of $25. I will revisit the stock if it dips below $10.