The exploration and production (E&P) sector will continue to benefit from "very favorable" industry fundaments as the year progresses because of two factors: strong earnings because of high commodity prices that have far outpaced service costs and "attractive" stock valuations, according to a report by Raymond James' energy analysts.
"As this environment proves sustainable, rising E&P cash flows should lead to continued growth in capital spending, particularly on drilling," said analysts J. Marshall Adkins, Wayne Andrews and James M. Rollyson. "This should result in more pricing power, higher revenues, and solid share price appreciation for oil service companies.
"Our bullish oil and gas thesis also translates into a bullish stance on coal" the analysts wrote. "The stage appears to be set for higher average fossil fuel prices for years to come. This bodes well for the coal industry, since higher oil and gas prices should and have equated to higher prices for coal."
Energy stocks have outperformed the broader market in 2004 and year-to-date in 2005, and the analysts said they remain "firmly supportive of the E&P space" mostly because of the sustained high commodity prices.
"We look for solid absolute and relative stock price performance from the group as the market continues to incorporate higher long-term commodity prices into valuations." The market, they said, is valuing E&P stocks using long-term price expectations of $33/bbl for oil and $5.25/Mcf for natural gas, "which is well below our current forecasts of $47.00/$7.50 and 24-month New York Mercantile Exchange strip prices of $52.00/$7.25."
Of the stocks Raymond James covers, the analysts said that the entire group will move up on the strength of prices, but "we find the shares of Anadarko Petroleum and Pioneer Natural Resources to be particularly attractive from a valuation standpoint, given that they are trading below $1.60/Mcfe.
"We believe that the shares of Chesapeake Energy and XTO Energy will perform well in light of our robust natural gas price outlook and both companies' high natural gas focus, strong margins, high organic production growth rates, and deep drilling inventories. Furthermore, we continue to be bullish on Apache Corp. and Noble Energy for their solid growth profile, balanced reserve mix and savvy management."
Balancing current valuations, risk and per-share production growth opportunities, Raymond James' top picks in the small and midcap group are Brigham Exploration, Cimarex Energy (which is merging with Magnum Resources), Comstock Resources, Forest Oil, Houston Exploration, InterOil Corp., Plains Exploration & Production, Remington Oil & Gas, Ultra Petroleum, and Western Gas Resources.
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