Why Private Equity Firms See Value in Energy Stocks

Private equity firm The Blackstone Group L.P. (BX) recently committed $500 million to oil producer Linn Energy LLC (LINE) for its drilling projects.This is yet another in a series of moves by private equity firms to increase their investments in energy stocks.

Linn EnergyDo these moves indicate there’s value in the energy sector?

High yield stock Linn Energy recently cut its drilling budget and slashed its dividend prior to the Blackstone investment. Linn chopped its dividend from $2.90 a share down to $1.25, and cut its budget more than in half, down to $730 million for 2015.

Linn Energy, like so many of the smaller producers, has seen its business pressured by the massive drop in crude oil prices since June. LINE stock fell dramatically in the last year from $34 to just over $11. After the dividend cut, though, it still yields 11%.

Private Equity Bullish

Despite the plunge in crude oil prices in the last year and the beating most energy stocks have taken, private equity firms are bullish. Private equity firms such as Blackstone, The Carlyle Group LP (CG), Apollo Global Management LLC (APO) and others, which have reportedly seen their energy portfolio values fall hundreds of millions of dollars each, are putting more capital into energy stocks. Apollo has $5 billion invested in the industry while Carlyle has roughly $20 billion.

Just last month, in a Bloomberg article, Blackstone CEO Stephen Schwarzman said at a conference that the energy sector now represents investment opportunity. In the same article, this view was echoed by other private equity leaders, such as KKR & Co. L.P. (KKR) co-CEO Henry Travis as well as Carlyle’s co-CEO David Rubenstein, who said, “It’s a great time to buy.”

What they’re talking about is oil.

Private Equity Plays

Blackstone will receive essentially an 85% stake in the wells it’s funding for Linn Energy. Private equity firms are backing other energy stocks as well. Apollo continues its strong involvement with EP Energy Corp (EPE), while Carlyle is heavily invested in a number of small producers.

The private equity investments in energy stocks confirm that they see value in the sector. It’s important to note that the private equity firms see the energy stocks as a long term investment theme. Most are braced for a further decline in oil prices this year which may of course negatively impact energy stock prices. But the long term outlook — think in terms of years — is positive.

The key question for individual investors is always whether we should follow what the professionals or institutions are doing. It’s noteworthy to see what major hedge funds and famous investors are doing, likewise private equity firms in this case with all their activity in the energy stocks.

But should you plunge in?

Keep in mind that as in the case of hedge funds, private equity firms are capable of doing things we individual investors can’t. Private equity can invest large sums in a company to the point of being a major stakeholder, or even buy firms outright. The rest of us obviously can’t do this.

But the main idea, that private equity sees long-term value in energy stocks, is a theme we individual investors can apply. And the value isn’t limited to smaller energy stocks. Remember, it’s mainly about the oil.

The nature of private equity’s bet on energy stocks contains at its heart the idea that oil is a beaten down commodity, that its value will ultimately rise and that energy stocks will rise along with this. Like most value ideas, it takes time and investors need to be patient.

How to Buy Energy Stocks

If you go along with this classic value idea on energy stocks, what should you buy? You can carefully shop for bargains among the smaller producers like Linn Energy or EP Energy, though the smaller companies still carry the most risk.

You can make the small producers a lesser part of your energy stock portfolio. You can include or even focus on big oil, choosing from among familiar names such as Exxon Mobil Corporation (XOM), Chevron Corporation (CVX), ConocoPhillips (COP), Royal Dutch Shell plc (RDS.B) and the like.

Go slowly, add to your positions over weeks and months, even a couple of years. The majors have the wherewithal to withstand the squeeze in oil prices. Think of the investment implications of Exxon CEO Rex Tillerson’s comment to CNBC that his company can weather $40 oil.

What he’s talking about is a classic economic margin of safety for major producers in the oil business. That’s an investable theme right there. Value investors should look at energy stocks now.

As of this writing, Greg Sushinsky was long LINE, RDS-B, and XOM.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/01/private-equity-stakes-signal-value-energy-stocks/.

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