The stocks of exploration and production (E&P) companies are set to appreciate 25% to 35% in the next 12 months, making it time for investors to buy, according to Raymond James Energy’s latest Stat of the Week.

“No longer is it reasonable to ignore the enormous run-up in gas and oil prices over the last nine months and forsake the equity value of the E&P companies that will directly benefit from the sustainable shifts in commodity prices,” said analysts Jeffrey L. Mobley and Wayne Andrews. “It is now time for the ‘thunder run’ of buyers to E&P stocks.”

In their analysis, Mobley and Andrews noted that the market has not responded to the huge run-up in natural gas prices over the past nine months, and historically, 50% to 70% of the price performance of E&P stocks is caused by gas prices. “Since September last year, natural gas prices have increased from $3.50/Mcf to over $5.50/Mcf, while E&P stocks have essentially been flat.”

Although investors may be cautious of the sector, the analysts said there were “strong fundamentals in place,” as natural gas is showing resilience at current price levels and “futures markets are implying that strong prices are, in fact, sustainable.” The analysts said they “believe the discrepancy between gas prices and equity valuations cannot persist much longer. Therefore, we believe E&P stocks must go up.”

Mobley and Andrews also believe that earnings and cash flows from E&Ps “will far exceed more investors current expectations, which may lead to the much anticipated catalyst to get the sector moving. Once the market finally believes in the ‘step change’ to $5.00/Mcf gas prices, further investor enthusiasm should follow.”

Valuations of E&P stocks “are at very low levels,” said the Raymond James’ analysts, and that will provide “substantial downside protection” for investors. They focused on the forward earnings before interest, taxes and depreciation and proved reserve multiples and found that E&P stocks are currently trading at about $1.30/Mcfe, including upside/going concern value for unproved reserves.

“If we are right on our natural gas price outlook (of $5/Mcf into 2004), the market should be in store for a massive asset revaluation to more appropriate levels. If E&P stocks do not respond, values may ultimately be achieved through the mergers and acquisitions market or through stock repurchase by companies with their substantial excess cash flow.”

The only wild card is oil prices, said the analysts. They believe oil prices will average around $25/bbl with OPEC production cuts. “Despite this potential risk, we still believe significant upside potential remains even in an environment of moderately lower oil prices. In any event, we think the downside in E&P stocks would still be limited in the lower oil price scenario, given current low valuation levels.”

In a robust market, they believe “virtually all” of the E&P stocks will rise. However, some are expected to do “exceedingly well,” including Comstock, Denbury, Evergreen, Southwestern, Ultra Petroleum, Anadarko, EOG Resources and Pioneer Natural Resources.

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