To find undervalued energy stocks that offer upside and
stability, look for utilities with undervalued energy assets.
That's Ray Saleeby's preferred method, and the experienced value
investor has shared his top picks in this
interview, along with some research pointers. Read on to find
spin-off pearls missed by overspecialized market analysts.
The Energy Report:
Ray, your firm, Saleeby & Associates Inc., focuses on
identifying companies with turnaround potential-good firms that
trade at a discount, but enjoy a solid customer base in
hard-to-enter industries. Why?
I buy stock in companies that are discounted to the intrinsic value
of their operations. This differs from growth investing, which
focuses on companies that outpace their peers for earnings. It
differs from momentum investing, which attempts to time stocks on a
short-term basis. My philosophy of value is more long term and
contrarian. I buy companies when they are
I handle $220 million [$220M] plus, of which about $100M is in
the utility and energy industry. I buy a lot of utilities because
there are tremendous barriers to entry to that sector. One does not
find a gas utility popping up every other week. For the same
reason, I like the construction aggregate business. And I
absolutely love the water business. It's a resource that we're
going to need forever. I also invest in defense electronics and oil
and gas. There are also barriers to entry in the drugs and medical
Tell us about your research process.
I have a library of 60,000 different research articles going back
20 years. I subscribe to about 60 different periodicals that
provide financial reports and different types of information about
various companies. I look at annual reports and presentations by
companies. But before I buy a stock, I call up the management and
ask detailed questions.
How do junior gas and oil companies fit into this model?
With the juniors, I take a very hard look at management. Does it
have a track record of success? Are the managers personally
invested in the firm? Second, I like companies that have a
first-mover advantage in acquiring developable property. Clusters
of wells provide economies of scale where drilling rigs can easily
be moved around. Energy is a commodity business and access to
capital is very important. And being a low-cost provider is crucial
when dealing with commodities, as we never know when the market
will fall. And, last but not least, I want companies that have a
good hedging strategy. And for tax reasons, I look toward MLPs
[master limited partnerships].
Let's talk about discounted utilities with exploration and
development arms. Where are the undervalued opportunities in that
One of the positives about operationally diversified utilities is
that they can spin off resource development divisions. Now, a
utility analyst is completely different than an oil and gas
exploration analyst. With a spin-off, suddenly there are two
different types of analysts following two related companies, and
the new firm can get double coverage. Secondly, the new managers
may have more incentive to produce than they did when they were
operating under the parent company's top management. Also,
utilities are heavily regulated; spin-offs are usually
The negative aspect of a divestment is that utilities are
generally financially stable and can provide a cushion for
commodity capital into its development divisions through boom and
bust times. And the flip side of a spin-off in the analytical
marketplace is that the typical oil and gas analyst does not
generally understand how to analyze utility operations, whereas the
typical utility analyst does not understand how to value oil and
gas assets. So the double coverage can turn into a negative, a
discount of real existing value.
What are some promising names in this space?
Questar Corp. (
) is a perfect example. Originally, Questar was a utility that also
had a gas exploration business. About two years ago, it spun it off
as QEP Resources Inc. (
), and it's been very successful and is leveraging the resource
needs of its parent. Questar supplies natural gas to a lot of
customers. It is very competitive with electric and it steals
customers that have a choice between electric or gas meters. It is
well diversified; its Wexpro division also develops and produces
gas for the utility and it is very attractive on its own merits.
Another factor to consider is that a lot of natural gas companies
are not able to make a profit in the current price environment,
unless they are hedged. Some are starting to shift their
exploration dollars toward oil, rather than gas, because oil is
holding up relatively well relative to gas prices. QEP Resources is
well positioned in gas but has recently made a couple of
acquisitions in the oil business to help balance things out. It's
even buying back its own stock.
An example of a well-diversified company that has
is National Fuel Gas Co. (
). It is a combination of utility, pipeline, storage and explorer
and producer [E&P] company with, I believe, some of the best
assets in the U.S. It has 800,000+ acres in the Marcellus fields
close to the New York consumer markets. It's been around for 100
years, it has a good balance sheet, and it has a history of paying
increasing dividends. Looking deeper, it had some problems with
executing on oil-producing land it owns in California. And it was
not able to get a joint partner for its Marcellus field after
natural gas prices went down. If gas prices start popping up again,
National Fuel could be a takeover target. The Marcellus acreage is
extremely valuable and it can be better exploited if natural gas
goes higher. Mario Gabelli has a position in the company, as do
How hard is it for an exploration company to switch over from
natural gas to oil?
Some fields are more attuned to gas, some to oil. It is hard to get
out of leases to switch over from one to the other resource. And
drilling crews have to be shifted around, which is expensive. But
there's a glut of gas right now in a lot of different markets. And
that's one of the reasons why the MLP sector is a very attractive
sector going forward.
How do MLPs work?
Master limited partnerships are structured so that income flows
directly to the investors. It is not double taxed at the corporate
level. Investors receive K-1 forms versus 1099 forms for their IRS
tax returns. However, it is advisable that you really know what
you're doing before diving into a complicated MLP arrangement. MLPs
may not be suitable for all investors.
What other utility-centric natural gas companies provide good value
Energen Corp. (
) is a small utility in Alabama that runs a large exploration
company in the Permian Basin. It is currently out of favor in the
market - discounted to its asset value. It is very conservative. It
hedges a lot, and has 30 years of dividend growth. It uses the
dividend income from the utility to grow the oil and gas
exploration and development business. It's a good value find.
Why is Energen discounted?
As a combined utility and oil and gas exploration company, it is
subject to the kind of analyst misdiagnosis I explained earlier.
But Energen's cash flow and its EBITDA are cheap comparable to its
peers. It has proven reserves. Management is competent, even though
it just reported a disappointing quarter: gas prices plummeted and
the firm was not as well hedged as it had been previously due to
Is there a limit on the supply of natural gas?
Some say that the U.S. is the Saudi Arabia of natural gas. But the
real question is: Is the existing supply an economic supply?
Companies simply cannot make money exploring for gas at the current
price. Capital is moving into oil. Sufficient cash is not spent on
the necessary infrastructure, such as storage and transportation,
to take the gas to the domestic consumer and to international ports
for export. The other problem is that it takes a while for
utilities to shift over from coal to natural gas. Facilities are
being built, but it takes time. On the upside, there are
transportation uses for gas, especially for heavy trucks and
commercial vehicles and government vehicles. Incentives are needed
to support that transformation. The more these gas-dependent
industries develop, the higher the price of gas will rise,
providing more capital for more infrastructure and development. But
a lot of E&P firms are keeping the gas in the ground for
Are there any energy holding companies that reflect your investment
MFC Industrial Ltd. (
) is a company that has done phenomenally well. A $1 investment in
MFC a little over 10 years ago is worth $6.50 today. It's averaging
a 20% compounded return. MFC is a true value investor. It turns
energy and resource companies around and monetizes them. It
recently bought Compton Petroleum. The management is very
shareholder oriented; executives own a large stake in the company.
It is a small firm, but it sources and delivers commodities and
resources throughout the world.
South Jersey Industries Inc. (SJI) is a utility in New Jersey.
But probably 30% of their business is nonregulated. An investment
of $6,000 in 1985 - with reinvesting the dividends - would now be
worth $720,000. Management has just been top notch in creating
To conclude, are any of these firms looking at renewable energy
South Jersey is involved in solar. But with the revolution in cheap
natural gas, a lot of the solar and wind ventures have been put
aside. A few decades down the line, solar is going to be the
solution. The world has an abundance of sun. There are, however,
cost and efficiency problems with solar and wind due to storage and
transmission of power. Alternatives have a role in the future, but
we have an abundance of natural gas at this time.
Thanks for speaking with us, Ray.
This interview was conducted by Peter Byrne of
The Energy Report
and can be read in its entirety at
formed Saleeby & Associates Inc. in 2001 after 15 years working
with brokerage firms such as R. Rowland Co. and Forsyth Securities.
Saleeby published a newsletter between December 1987 and May 1996
that received national attention. Articles written about him and
his recommendations have been published in
USA Today, The Wall Street Journal, St. Louis Post-Dispatch, St.
Louis Business Journal
and other periodicals.
1) Peter Byrne of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are sponsors
The Energy Report:
3) Raymond Saleeby: I personally and/or my family and/or Saleeby
& Associates Inc.' clients own shares of the following
companies mentioned in this interview: Natural Fuel Gas Co.,
Questar Corp., QEP Resources Inc., Energen Corp., MFC Industrial
Ltd. and South Jersey Industries Inc. I was not paid by Streetwise
Reports for participating in this story.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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