Oil Stocks' High-Octane Surge


Given the state of energy prices, it isn't too surprising that as of July 15, energy was the best-performing stock sector in the Standard & Poor's 1500 index: up 21.6%, vs. 1.9% for the index as a whole, according to Tina Vital, S&P analyst of integrated oil and gas stocks.

Within the energy sector, the oil and gas refining and marketing segment was up 38.5% year to date, and oil and gas exploration and production up 35.7%. Says Vital: "This illustrates that the drivers of the energy sector are strong oil and gas prices and strong refining margins."

As for specific energy stocks, Vital has strong buy ratings on ConocoPhillips (COP), Exxon Mobil (XOM), and Total (TOT), as well as Valero Energy (VLO).

Oil prices, around $57 a barrel as of July 19, are ahead of S&P's forecast of $52, Vital notes. S&P thinks the price will stay above $45 through 2008.

These were a few points Vital made in an investing chat, presented on July 19 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat.

Note: Tina Vital is an S&P Equity Research analyst. She 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 analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' 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, click on "Investment Research," and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

Q: Tina, first tell us how the energy sector has been doing broadly, relative to the market.

A: Well, the energy sector has been one of the best-performing sectors within the S&P 1500 index this year. As of July 15, the sector was up 21.6%, vs. 1.9% for the S&P 1500. In our view, this reflects strong earnings, which were up 39% in the first quarter of 2005, and S&P projects earnings within the energy sector will rise 28% in the second quarter and 23% for the full year 2005. This reflects both strong oil and gas prices and continued strong refining margins.

Q: What's your forecast for oil prices and their impact on stocks?

A: WTI oil prices were steady today near $57 but are still above our forecast of around $52 for the year, using the data from Global Insight, which is an independent economic forecaster. Using this data, we believe WTI oil prices will remain above $45 through 2008. This is supported by strong demand and limited supplies.

Q: What are the downside risks of investing in oil?

A: Projection of commodity prices, and oil and gas prices, is very difficult. And compounded with geopolitical risk and potential changes in economic and industry conditions, earnings forecasts for energy companies may miss our expectations, as prices may fail to meet our projections and companies may be unable to achieve their upstream projection targets.

Q: What are your favorites among the big integrated oils, Tina?

A: I cover the large integrated oils and independent refiners. My favorite 5-STAR (strong buy) recommendations include ConocoPhillips (COP). It's currently trading at $60, and my target price is $72. Dividend yield is 2.1%. The next one is ExxonMobil (XOM). It's currently trading at $59, and the target price is $73. Dividend yield is 2%.

Both of these companies, we believe, offer solid upstream production growth and should benefit on the downstream from their superior ability to refine lower-quality crude oil feed stocks to their refineries. The cost of these lower-quality feedstocks offers significant discounts in the current marketplace, which we believe will continue over the next several years.

On the other side of the pond, we like and have a strong buy recommendation on Total (TOT). It's trading around $126, and our target is $135. The dividend yield is 2.4%. This international oil company is focused outside of North America but offers strong upstream production growth and solid reserve replacement at below-average cost, and its refineries are also able to process lower-quality crude oils on a world-class scale.

Q: How do you think the Unocal (UCL) situation will play out? The rival bids are from Chevron (CVX) and China National Offshore Oil (CNOOC).

A: We believe the current CNOOC bid is probably not high enough to derail the Chevron deal. Given the likely complicated review of the CNOOC bid, we believe that the Chevron-Unocal deal could close before an in-depth review is undertaken.

Q: Can you help here? I'm looking for an oil stock with a good yield.

A: Well, in general, the best dividend yields are offered by pipeline master limited partnerships and the integrated oil and gas companies. Exploration and production, as well as oilfield service and drillers, typically offer very low dividend yields.

That said, we've gone through my picks for the integrated oils -- XOM, COP, and TOT. But my colleague Roy Shepard covers pipelines and tankers. He has no strong buy recommendations, but he has three buy (4-STARS) recommendations. They include Amerigas Partners (APU), a propane distributor. It's currently trading at $32. His target is $34. Its dividend yield is 6.8%.

He also likes two pipeline companies that focus on refined oil products. Kinder Morgan Energy Partners (KMP) is currently trading at $53. Target is $56, and dividend yield is 5.8%. And he also likes Buckeye Partners (BPL). It's trading at $47, target is $50. Dividend yield is 6%.

Q: Valero Energy (VLO) -- any thoughts on its stock?

A: I have a strong buy (5-STARS) recommendation on Valero Energy. It's currently trading at $81, and my target is $100. Dividend yield is 0.5%. We see Valero trading at a 15% discount to its U.S. refining peers. However, we believe it should trade at least in line with its peers, given its significant ability to refine heavy sour crude-oil feedstocks, which offer a considerable pricing discount to light sweet crude oil.

Q: What are your thoughts on BP (BP) -- buy, sell, hold?

A: I cover BP with a 4-STARS (buy) recommendation. It's currently trading around $66. Our target price is $73. Dividend yield is 2.7%. We expect above-average upstream production growth near 5% through 2008, and, as one of the largest refiners in the U.S., we estimate its heavy oil conversion capacity at about 67% of its U.S. distillation capacity and about 43% globally. We believe BP is well positioned to benefit from its ability to process cheaper, lower-quality crude-oil feedstocks.

Q: Can you share your views of giant Royal Dutch (RD)?

A: I cover Royal Dutch Petroleum with a hold (3 STARS) recommendation. It's currently trading around $62. Our target price is $65. The dividend yield is 2.2%.

We believe the company will benefit from its planned unification under one British parent company, which will be called Royal Dutch Shell PLC, headquartered in the Netherlands, which we believe will become effective July 20 (8 a.m. London time, to be precise). We believe this will add clarity and ease to its internal governance process.

Q: How about Occidental Petroleum (OXY)? I bought OXY at 56 -- now it's 80. Should I unload?

A: S&P's Charles LaPorta covers Occidental Petroleum with a 4-STARS (buy) recommendation. The company is currently trading at $80. Chuck's target is $95. It has a 1.6% dividend yield. Charles views Occidental as offering solid upstream growth prospects, but at low relative upstream costs relative to peers. With a majority of the company's reserves focused on oil in the U.S., we believe its future growth will be driven by its Middle East projects.

Q: What segment of the energy sector has been doing best in this market?

A: Year to date as of July 15, energy was the best-performing sector within the S&P 1500 index. And within the energy sector, the oil and gas refining and marketing subindustry was up 38.5% year-to-date. Oil and gas exploration and production was up 35.7%.

This illustrates that the drivers of the energy sector are strong oil and gas prices and strong refining margins. In particular, those refiners with the ability to process lower-quality oil feedstocks have benefited from very strong margins this year.

Q: Finally, can you refresh us on your strong buys in integrated oil and gas?

A: Our favorite 5-STAR recommendations have significant heavy sour crude refining capacity. Exxon Mobil, ConocoPhillips, and Total at the same time offer solid upstream production growth -- and a nice dividend yield.


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