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|  | AUGUST 27, 2004
What's Cooking in Energy Stocks S&P analyst Craig Shere says in the area of utilities and energy merchants his top picks are AES and Constellation Energy The prices for both natural gas and oil should moderate over the next year, according to a forecast reported by Craig Shere, Standard & Poor's analyst covering natural gas utilities, energy merchants, and pipelines. Specifically, the forecast calls for the average fourth-quarter gas price to fall from $6.08 per million Btu in 2004 to $4.84 in 2005, and for oil to average around $35 per barrel next year. And he notes that S&P still recommends that investors overweight energy in their portfolios. Among the stocks he covers, Shere has buy rankings on two energy merchants. The first is Constellation Energy (CEG ), which has managed to maintain an investment-grade credit rating and shows above-average growth in earnings per share but trades at a discount to its peers. The other is AES (AES ), "another energy merchant that has made the leap from a vicious deteriorating credit cycle to a more positive cycle of debt reduction, improved cash flows, asset sales, and debt refinancing." On the issue of whether such companies are still suffering an "Enron hangover," Shere says it's "more like the afternoon after, rather than the morning after," with few companies in near-term financial distress and the likelihood that wholesale power margins will eventually recover. These were among the points Shere made in an investing chat presented Aug. 24 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk. Note: Craig Shere is a Standard & Poor's Equity Analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research," then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts." Q: Craig, what's the latest on energy prices? And where are crude-oil prices going for the rest of 2004? A: We expect natural gas prices to average $5.42 [per million Btu] in 2005, which is down from $5.88 in 2004. We're looking for oil in 2005 to average around the $35 range, as the premium for concerns about Yukos, Iraq, and Venezuelan politics finally add up. Q: Are oil shares dropping because they're already fully valued for the future? A: There has been a substantial run-up in prices in the oil sector, followed by some downside correction in the last couple of weeks. We still recommend an overweight allocation to the energy group.... But your observation that the shares are not necessarily cheap may be reasonable. Q: What effect will the high energy prices have on the fuel-cell industry? A: This certainly increases public and private interest in fuel cells, which are still much more expensive than combustion engines. But increasing natural gas and gasoline prices certainly make large users begin to add up the potential economics of fuel cells over the long term. In addition, the global political environment would argue for more public support of fuel-cell development. If you recall, President Bush made specific comments about the need to advance fuel-cell research in his State of the Union address. Despite these positive factors, fuel cells don't have an infrastructure in place for mass consumption and are simply more expensive than existing alternatives. I've little doubt that our grandchildren will use lots of them. But the big question is whether we or our children will make any money off it. Fuel-cell companies are very risky and comparable to the biotechs of the energy world. Q: Opinion on AmeriGas Partners (APU ) and Enbridge Energy Partners (EEP )? A: We have hold rankings on both of these master limited partnerships. Q: Are XTO Energy (XTO ) and Anadarko Petroleum (APC ) good gas stocks for the future? A: We have hold rankings on both of those companies as well.... Keep in mind that I am primarily a utilities and energy merchant analyst, covering regulated utilities, as well as more volatile companies like Calpine (CPN ), Williams (WMB ), El Paso (EP ), and diversified utilities in between, such as Duke (DUK ), Dominion Resources (D ), and Constellation Energy (CEG ). Q: So in the areas of your specific coverage, what are your best picks, Craig? A: I have a buy rating on Constellation Energy and on AES (AES ). CEG is one of the few multi-utilities with a majority of earnings from energy merchant operations that has managed to maintain an investment-grade credit rating. Despite what we see as above-average EPS growth, near 10%, the stock trades at a hefty discount to slower-growth utility peers. AES is an example of another energy merchant that has made the leap from a vicious deteriorating credit cycle to a more positive cycle of debt reduction, improved cash flows, asset sales, and debt refinancing.
BW MALL
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