A friend recently asked me what I was doing win the market right now. My answer was, “Not much outside of energy, miners and small banks at the moment.” My friend understood the small banks and miners, as both of those sectors are clearly cheap, but was puzzled by my fondness for energy stocks right now. After all, why would a staunch deep-value type like me be interested in energy when the Energy SPDR (XLE) was hitting new highs and was up as much as the S&P 500 in the past year?
The answer to that question lies in the makeup of the ETF.
If you look at the holding of the ETF, Exxon-Mobil (XOM) and Chevron (CVX) make up almost a third of the index. The top 10 stocks make up 60% of the fund, and they are all large-cap stocks in the S&P 500. They will be heavily influenced by the trading activities of asset allocators, index traders and investment funds that are just index tweakers in disguise. Many of these energy stocks pay dividends and have been pushed up by yield-seeking investors over the past few years.
However, when you look outside the index, there are some very cheap stocks in the sector. I have talked in the past about companies like Swift Energy (SFY) and Hercules Offshore (HERO) that trade at significant discounts to their asset value and offer patient investors the opportunity for outsized long-term returns. This morning, I sat down and searched for energy stocks that trade at a discount to the Graham Number calculation of fair value.
I am particularly intrigued by two companies that provide services to the oil and gas companies and are cheap based on the combined asset and earnings value calculation.
PHI Corporation (PHII)
PHI Corporation (PHII) provides helicopter services to companies that need to get personnel and supplies out to offshore oil and gas rigs or get them off quickly when a storm is approaching. It also has a medical division that provides air ambulance services for hospital and other medical facilities in 18 states. PHII stock trades at just 80% of the Graham Number calculation and
seems to be a bargain based on its asset value and earnings potential. As drilling activity picks up in the Gulf of Mexico, PHI should see a strong increase in demand for its services, driving revenues and profits. Hopefully, the stock price a lot higher over the next several years.
North American Energy Partners (NOA)
North American Energy Partners (NOA) provides mining and construction services to companies looking for oil in the Canadian oil sands region. NOA has a fleet of almost 900 pieces of heavy equipment used in mining and excavating oil sands, making it the largest fleet available in Western Canada. North American Energy has been seeing strong results in the past year, profits have grown by 36% this year, and some analysts expect the bottom line to double next year. In spite of all this positivity, the stock is a bargain, shares of NOA stock trading at just 50% of the Graham Number valuation.
Bottom Line: Large-cap energy stocks have been pushed higher by indices and yield buying. The smaller, less well-known companies in the sector still offer an opportunity for value oriented investors to find solid bargain issues.
As of this writing, Tim Melvin was long SFY and HERO.