Energy Selling Overdone

With the XLU down 15% from its high, you’d think energy prices were tanking. Instead we have $63 crude oil and $13 natural gas. While a warm winter would bring natural gas prices down considerably from here, earnings estimates for energy companies right now are probably based on no more than $50 oil and $7 natural gas, nowhere near where we are now.

Stocks like Chesapeake (CHK), Suncor (SU), and Plains (PXP) are trading at 8-10 times 2006 earnings. Plains is getting crushed today, in fact, on news of charges it will be taking from its hedging positions. However, that will be money well spent since it assured they could get high prices for their product in 2006.

Unless energy prices plummet from here, current earnings numbers will prove conservative. The volatility is hard to stomach, but these stocks are too cheap to ignore if you don’t have your 10% position in energy yet.

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2 Thoughts on “Energy Selling Overdone

  1. David Hopkins on October 13, 2005 at 11:49 AM said:

    I have positions in ConocoPhillips (COP) and Cimarex Energy (XEC) and bought both when their p/e’s were approximately 9 and 10 respectively. Both have significant upside, in my humble opinion. Cimarex, for example, is considered the cheapest natural gas play in the market by many. Your data on how O&G companies are currently being valued by the market is valid. At some point, one would think that the market will wake up and properly price this sector, even given their runnup over the last year. Does DELL, for example, deserve a market multiple near 3X that of many of the energy stocks? I dare say that they do not. Meanwhile, I have to admit, watching the value of my portfolio (heavily titled toward energy) sink like a rock day after day is extremely difficult to swallow. But alas, I am an investor and not a trader, and firmly believe that patience will be rewarded with regard to the energy sector.

  2. Chad Brand on October 13, 2005 at 12:49 PM said:

    The market is unwilling to assign higher multiples because many do not believe oil prices will remain high. Some still think hedge funds have been propping up the price and that future demand from China and India has been overstated.

    We saw similar events occur in recent years as people thought housing would collapse as well. Home builders and mortgage lenders traded at 7x-8x earnings. Only when it turned out that the earnings continued to be delivered did the stocks rally to account for that.

    Given that I am a bull on commodities, I remain confident that the few energy stocks I have invested in will deliver the earnings, and when that happens, the stocks will resume their upward move.

    You can see the same thing with a stock like Phelps Dodge (PD). Current estimates have 2006 EPS falling 30%, even though copper is hitting new highs. Could copper prices fall in the next year? Sure. But what if they don’t? All of the sudden you have a $120 stock that can earn $20 per share.

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