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5 Oil and Gas Plays - Pricey but Worth Considering

In theory, the price of a stock is not related to the return that it may offer. What this means is that, for the same capital, a $100 stock (1x100) may offer the same level of return as ten $10 stock (10x10) when divided by its earnings per share. In this article, I analyze five oil and gas stocks to demonstrate how this could pay off for investors. The bottom line: investors should be indifferent to the price tag but instead focus on the potential return.

Exxon Mobil (XOM): Shares are trading around $86 at the time of writing, within a 52-week trading range of $63.47 to $88.23. At the current market price, the company has a market capitalization of $405.33 billion. Its latest earnings per share were $8.42, and it paid a dividend of $1.88, for a dividend yield of 2.20%.

Exxon Mobil is the world's leader among petroleum companies, which explore, produce, refine and market oil and gas. In terms of financial performance, Exxon appears to be doing very well. Its revenues consistently grew over the last five years with a recent year increase of 42%. Its business is profitable, with the latest gross margin of 15.06% (its gross margin averaged 26% for the last five years) and net margin of 8.44%. Even at $86 per share, the stock appears relatively cheap as suggested by its price to earnings ratio of 10.17. Other valuation approaches that use a variation of the discounted cash flow method may show figures suggesting that it is overvalued, but I say don't get discouraged by it. I would interpret the discrepancy between the price to earnings ratio and other valuation methods as Exxon being less overvalued than most stocks with similar risk profile. I recommend buying Exxon because of its reasonable price, dividend yield, its good track record, and outlook of strong demand for oil and gas.

Chevron (CVX): Shares are trading around $107 at the time of writing, within a 52-week trading range of $86.68 to $110.99. At the current market price, the company has a market capitalization of $212.07 billion. Its earnings per share during the last year were $13.53, and it paid a dividend of $3.09 (with a total yield of around 3.04%).

Chevron, just like Exxon Mobil, is an integrated energy company. It operates through its subsidiaries, which are engaged in petroleum operations, chemicals operations, mining operations, power generation and energy services. In terms of financial performance, I see Chevron as a slightly better performer than Exxon. It also has a proven track record of revenue growth. It's operationally more efficient than Chevron as shown by its gross margin of 33.41% and net margin of 10.92%. Another factor that makes Chevron attractive to investors is its dividend yield of 3.04%, which is higher than most of its peers. Some analysts noted that Chevron should have a higher dividend yield, since its payout ratio is only 22% (the same as Exxon).

The way I see it, what Chevron did was probably a compromise between expectations about dividends and growth. Oil and gas business is capital intensive and there are growth opportunities in the developing world. Therefore, its valuation as suggested by price to earnings ratio of 7.88 is cheap. I recommend buying Chevron because of its reasonable price, dividend yield, good revenue track record and increased demand outlook for oil and gas.

Anadarko Petroleum (APC): Shares are trading around $85 at the time of writing, within a 52 week trading range of $57.11 to $88.70. At the current market price, the company has a market capitalization at $43.35 billion. Its earnings per share during the last reporting period were negative ($5.32). No dividend was reported.

Anadarko Petroleum is one of the world's largest independent oil and gas exploration and production companies. In terms of financial performance, Anadarko performed well over the last two years. Its revenues grew an average of 30% for the last two years, although 2011 sales were just 87% of peak sales in 2007. I see this as a sign of potential and not weakness, which is supported by its average gross margin of 44% for the last five years. Anadarko may have posted a loss in the last reporting period, but this was due to capital expenditures on fixed assets of $6.65 billion. Adjusting for this unusual expense, Anadarko appears better than what its reported figures suggest, as it would have earnings per share of $8.03 and a price to earnings ratio of 10.91. On the other hand, the company may have accumulated debts while doing this and we still have to see whether this will work out just fine. Overall, unlike other high tag-price stocks, I recommend selling Anadarko, primarily because it seems Anadarko has just started on an expansion track, and it may take a few years before operations normalize. I don't see Anadarko as a weak stock, its just that other oil and gas stocks, such as Exxon and Chevron, offer the same or better returns for less risks.

Apache Corporation (APA): Shares are trading around $109 at the time of writing, inside a 52 week trading range of $73.04 to $134.13. At the current market price, the company has a market capitalization of $41.21 billion. Its earnings per share during the last reporting period were $11.37, and it paid a dividend of $0.17 (with a total yield of around 0.62%).

Apache Corporation is an American independent oil and gas corporation, which is almost the size as Anadarko. In terms of financial performance, Apache outperformed Anadarko, particularly in the last two years. It reported a gross margin of 58.77% and net margin of 27.14%. Return on equity is a respectable 17.18% resulting in earnings per share of 11.37. It is, however, very stingy with dividends, which is a turn-off to investors. Again, even with a high price tag of $109, I recommend Apache to investors because of a low price to earnings ratio of 9.63, and continuing profitable operations.

EOG Resources (EOG): Shares are trading around $116 at the time of writing, within a 52 week trading range of $66.81 to $121.44. At the current market price, the company's market capitalization is at $30.58 billion. Its earnings per share during the last reporting period were $4.05, and it paid a dividend of $0.17 (with a total yield of around 0.59%).

EOG Resources is another American independent oil and gas corporation, which is almost half the size of Anadarko or Apache. In terms of financial performance, EOG performed well with consistent profits over the last five years. In the fourth quarter of 2011, the company reported a gross margin of 58.21% and a net margin of 12.11%. EOG appears less profitable and pays lower dividends compared to its big rivals. But its advantage is that it may offer a higher upside to investors because of potential growth coming from its sizable capital expenditures over the last five years. Of course, going for EOG's potential upside, instead of jumping in with Exxon or Chevron, would mean taking on bigger risks. Despite this, I recommend buying EOG for its consistent profitability and strong growth prospects.

About the author:

StockCroc
I'm mostly interested in income investing using dividends, preferred stocks and other debt instruments, and pair trading.

I fundamentally analyze every business from the top down.

In my personal life, I have a strong Jewish faith and enjoy playing Scrabble and entrepreneurship.

Visit StockCroc's Website


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