Wall Street Sends Energy Mixed Signals on Prices, Stocks

Energy companies were sent mixed market signals as analysts last week were trying to deal with and digest warnings of a possible recessionary economy, widespread stock sell-offs and teetering stock prices on a Wall Street that still was recovering from the destruction caused by terrorist air assaults.

Amid the negative economic fallout from the attack in New York City, as well as the "unprecedented record-high storage builds" over the past two weeks that have caused the price for the near-month gas futures contract to plunge to near $2 and cash prices in the Rocky Mountain regions to drop below $1/MMBtu on Friday, analyst M. Carol Coale of Prudential Securities Inc. lowered or left unchanged her 2001 earnings-per-share (EPS) estimates for seven of the 13 major energy (oil, natural gas and power) companies that she tracks, and raised estimates for the remaining six.

The companies with reduced or unchanged annual EPS estimates were Enron, El Paso Corp., Kinder Morgan Partners, Pacific Gas and Electric (PG&E), Questar, Reliant Energy and Western Gas Resources (WGR). Those that had their EPS estimates increased were Dynegy, Duke Energy, Kinder Morgan Inc., Enterprise, Equitable Resources and Williams Cos.

Ironically, even though she reduced or left unchanged the 2001 EPS estimates for more than half of the energy companies that she tracks, Coale expects all -- with the exception of El Paso, Reliant and Questar -- to turn in an EPS performance for the year that will either surpass or equal First Call's consensus estimates for them. For the third quarter, however, Coale anticipates that about half of the energy companies that she covers will report a lower EPS than projected by First Call.

For 2002, Prudential's Coale reduced her EPS estimates for Enron, El Paso, Equitable Resources, PG&E Questar and WGR.

Of nine energy company stocks she reviewed, Coale lowered her 2001 stock price targets for Dynegy (to $45 from $53), El Paso (to $55 from $72), Equitable (to $39 from $50), and Kinder Morgan Inc. (to $45 from $65). She increased the target for Enterprise (to $53 from $46), and left unchanged her stock targets for Duke Energy and Enron.

Coale said her EPS and stock forecasts were based on an average gas price (spot composite wellhead) of $4/Mcf for 2001, and a revised (lower) $3/Mcf average for 2002. Prices, she noted, were reeling from the effects of an "accelerating" weakness in industrial demand for gas. "Next year's forecast decline in gas prices marks the most dramatic decrease in the annual average, and many of the gas-sensitive stocks are not yet discounting a 'worst-case' situation." Under such a scenario, she believes El Paso, Kinder Morgan Inc. and WGR face the "greatest downside risk," while Dynegy, Enron, Reliant Energy and Williams have "upside potential."

In contrast, Raymond James & Associates last Thursday offered a more encouraging word to energy companies: energy stocks are "at or very near the bottom point."

Even prior to the terrorist attacks, Raymond James' analysts predicted that "several emerging events" -- weakening natural gas prices, October year-end tax loss selling by mutual funds, slowing global economies and potential broader market declines -- were likely to put "downward pressure" on a "psychology-driven" energy market, and that these events were likely to "crescendo in the October timeframe."

The attacks and the "events that have precipitated from the World Trade Center destruction have accelerated this anticipated downturn, and at the same time, have introduced several possible new positive catalysts to the energy markets. Accordingly, we think we are either at or rapidly approaching the bottom in the energy stocks in the next several weeks," said Raymond James in an "Energy Industry Brief."

The "positive catalysts" for natural gas prices that are emerging include the probability of oil supply disruptions, particularly in the longer term; signs of a fall-off in gas production later this year, which would lead to tighter supplies; and a drop in storage inventories beginning in January 2002, according to the Raymond James report. It further believes that reports have been greatly "overblown" about the impact of a slowing economy on energy.

Merrill Lynch analyst Donato Eassey reported "relatively few sectors have fared worse than energy" as the broader market has weakened. "And while we recognize that lower gas and oil prices are a real risk should a sustained economic downturn occur, this is clearly not our expectation." He cautioned, however, that not all energy companies should be "indiscriminately painted with the same broad brush."

During this time of economic uncertainty, Eassey said he continues to view the energy merchant companies as being oversold and possessing "substantial long-term investment opportunities." This group of companies includes Duke Energy, Dynegy, El Paso Corp., Enron Corp., Williams, Reliant Energy, American Electric Power, CMS Energy, Dominion Resources and UtiliCorp.

"While certainly not immune to these dynamics, the [energy merchants'] diversified operations throughout the energy value chain (regulated and non-regulated alike) should help provide a 'shock-absorbing' ability to earnings," he said. "With 15% growth in '02 expected to be intact even in a relatively flat economic environment, we gauge the [energy merchants] to now be the least expensive they have been in nearly 10 years. Consider that as a group, Dynegy, El Paso, Enron and Williams trade at an average [2002 estimated] P/E of 11.7x, below its prior floor of 14.2x in '95, and 42% below the 20.6x group average since '93."

Overall, Merrill Lynch sees a "positive stimulus from: 1) continuing volatility in gas and power prices, which should create additional risk management as well as energy trading opportunities; 2) high confidence in the long-term natural gas cycle; 3) winter around the corner; 4) strong earnings growth relative to a lackluster broad market; 5) increased [mergers and acquisitions] with declining cost of debt; and 6) the potential resolution of California issues."

While nearly every energy merchant company looks "enticing at current levels, we would particularly focus on the two that we believe have the least amount of near-term 'noise,' notably Williams and Dynegy, with each trading at [an] historically low valuation," Eassey said.

Carol Freedenthal, principal in Houston-based Jofree Corp., wasn't as optimistic. He expects to see much lower energy demand, reduced energy prices and weaker third-quarter earnings from companies. "You have to start with one basic premise, and that is energy consumption is directly tied to the economy. "If the demand for industrial products weakens, then so too does the demand for energy," he said, "unless we get a super cold winter starting tomorrow."

Even with a multi-billion dollar aid package for the airlines and other economic measures, Freedenthal seriously doubts that the Bush administration and Congress will be able to "reverse the economic slide fast enough."

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