Stocks Gurus Are Buying in Out-of-Favor Industries - Oil & Gas Edition

For most value investors, an out-of-favor industry is a bargain bin containing potential hidden gems. This mentality is what sent Bruce Berkowitz swashbuckling into financials on the tail of the financial crisis, and prompted Donald Yacktman to buy good "old tech" companies in 2011 when the market considered them a lost cause, for example.

While in recent days the Dow is hitting all-time highs, there are still some sectors that have felt the lift significantly less than others. The industry with the greatest number of stocks at three-year lows is Metals & Mining. (read more about that here). The industry with the third greatest number of stocks near three-year lows is Oil & Gas - Exploration & Production (E&P).

This segment of the economy currently has 12 stocks trading near their three-year low prices, with 15 trading at three-year highs, according to Stocks at Three-Year Lows . The low-priced stocks from this sector with the greatest number of Gurus owning shares of them are Devon Energy ( DVN ), Apache Corporation ( APA ), Arch Coal Inc. ( ACI ) and Entergy Corp. ( ETR ), according to Three-Year Low Guru Stocks (a Premium feature).

The exploration & production sector of the oil and gas industry comprises companies that search for crude oil or natural gas, drill exploratory wells and then extract the materials from beneath the ground or water. Stocks from the industry have declined 0.81% over the past year, and returned 8.12% year to date, the Standard and Poor's 500 Oil & Gas Exploration & Production Index as compiled by Bloomberg data shows. The S&P over the same span returned 13.56% and 9.26%, respectively. The median P/E ratio for the 463 companies in this sector globally is 14.62.

Devon Energy is a $22.8 billion market-cap E&P company whose current market price is 40.2% lower than its three-year high and that was purchased by the greatest number of Gurus in the fourth quarter of 2012, with five picking up the stock. In addition, a total of eight Gurus currently hold the stock, while three sold shares last quarter.

Mainly operating in the U.S. and Canada, Devon's fourth quarter production was composed of 23% oil, 16% of natural gas liquids and 61% natural gas. Lower prices in natural gas have the hit the company's financials hard. The annual average in 2012 came to $2.66 per thousand cubic feet, down from $3.95 in 2011 and $4.48 in 2010, according to the U.S. Energy Information Administration ( EIA ). Over the same time, U.S. production has increased to 25.3 million cubic feet, from 24 million and 22 million the previous years.

The trends have to do with record a sharp increase in energy reserves found in the U.S. The EIA found that proved crude oil and natural gas reserves in 2010 increased at a record annual rate of 12% and 13%, respectively. Natural gas reserves topped 300 trillion cubic feet for the first time.

"The use of horizontal drilling and hydraulic fracturing in shale and other tight rock formations played an important role in the increase of oil and natural gas reserves," said EIA Administrator Adam Sieminski. "For both oil and natural gas, these reserves increases underscore the potential of a growing role for domestically-produced hydrocarbons in meeting current and projected U.S. energy demand."

Another report by the agency found that crude oil domestic production should "rise sharply" from 2011 to 2019, and decline from 2020 to 2040. Domestic gas production, it found, should outpace domestic gas consumption by 2020. It is also predicting that the Brent spot crude oil price will decline from $111 per barrel in 2011 to $96 per barrel in 2015, and then leap to $163 per barrel by 2040.

Devon in 2012 reported a net loss of $206 million or $0.52 per diluted share, after an $896 million non-cash asset impairment charge, and total revenue of $9.5 billion, declined from $11.45 billion in 2011. With the cost pressures and trends, Devon is focusing on transitioning to a higher oil-weighted production profile. In 2012, oil production increased 20% over 2011, more than offsetting declines in natural gas production, which it has reduced.

The company has a P/E ratio of 35.7 and P/B ratio of 1, which is close to a 10-year low. Its dividend yield of 1.5% is close to a 10-year high of 1.6%.

One Guru, Jeremy Grantham, established a new position in Devon in the fourth quarter, at 74.700 shares, or 0.01% of his assets managed. Martin Whitman made the largest increase to his position, growing it by 63.92% to 4.66% of his total assets managed. Other Gurus who increased their holdings were Bill Nygren, Jean-Marie Eveillard, Paul Tudor Jones and Pioneer Investments.

Bill Nygren had this to say about Devon in his second quarter 2012 letter from Oakmark:

"Devon Energy ( DVN ) is another exploration and production company, the stock of which has suffered because of declining commodity prices. We find it interesting that the financial press often characterizes Devon as a natural gas "play," even though most of the company's revenues come from liquids. Over the past three years, the stock has declined in price despite Devon's significant growth in proved and probable reserves, as well as material debt reduction. Devon's management understands capital allocation to be a paramount responsibility and has demonstrated this through savvy asset sales and purchases, and by accessing foreign capital through joint ventures."

Arch Coal is an E&P stock that is 85.4% off its three-year high and that had the third greatest number of Guru buys in the industry, at three. Its share price is $5.34 on Friday - close to a 10-year low - after declining almost 59% over the past year, and it has a P/E ratio of 12, lower than the global coal industry average of 16.38.

Selling 157 million tons of coal in 2011, U.S.-based Arch Coal is one of the five largest global coal producers and markets. It focuses on supplying cleaner-burning, low-sulfur thermal and metallurgical coal used in powering generators and steel manufacturers around the world.

Its business has been negatively affected by the overall decline in the coal industry, in which U.S. demand has declined to a 24-year low, facing competition from cheap natural gas and regulatory challenges. In the words of famed investor Wilbur Ross in a July CNBC interview: "This time you have structural change. The EPA has clearly made a decision quite antithetical to coal with the new requirements that they imposed on the power plants. There won't be any more coal plants designed to be built with those rules in my view." But, he added, "Since I sold International Coal to Arch, I would have to pick Arch."

In 2012, Arch Coal reported $4.16 billion in revenues, down slightly from $4.29 billion in 2011. It also had a net loss of $684 million, compared to net income of $141.7 million. This included a fourth quarter impairment charge of $231 million tied to the company's goodwill and assets due to the fall of coal prices.

The company made a number of adjustments over the year as it responded to the changing environment, including growing its business in seaborne coal, which led to record exports of 13.6 million tons. To increase efficiency, it consolidated some operations and reduced capital spending by $145 million.

Arch management believes there is possibility of a market rebound in coal in the second half of 2013, and has boosted its cash position to $1.4 billion awaiting new opportunities. It also said in its annual statement it anticipates higher natural gas prices in 2013, making coal more competitive, as well as greater demand coming from China's manufacturing sector and colder winter temperatures in major coal-burning regions of Asia, leading to higher demand.

Gurus who invested in Arch coal in the fourth quarter were George Soros, Tom Gayner and Jeremy Grantham. Soros' venture was the largest, at 1.22% of Arch's shares outstanding. Energy Guru T. Boone Pickens, who initiated a position in the third quarter, decreased his holding by 0.59% in the fourth quarter, leaving him with a remaining 236,295 shares, equal to 1.7% of his total assets managed.

While nobody sold out, Steven Cohen reduced his holding's size by more than 96%, and Pioneer Investments sold 75.5% of theirs.

To find more companies trading near their three-year lows, go here. For Guru stocks at their three-year lows, go here (this is a GuruFocus Premium feature).About GuruFocus: tracks the stocks picks and portfolio holdings of the world's best investors. This value investing site offers stock screeners and valuation tools. And publishes daily articles tracking the latest moves of the world's best investors. GuruFocus also provides promising stock ideas in 3 monthly newsletters sent to Premium Members .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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