Which energy stocks should you buy?

Print This Post A A A

Today I’m embarking on an analysis of the Energy Sector, which is the first in a series of the 11 sectors of the ASX200. I plan to keep a similar format to each piece to enable comparison. (For an overview of the sectors and consensus recommendations, please read Breaking down the 11 stock sectors.)

My version of a High Conviction equity portfolio starts with the top 100 companies that attract a sufficiently strong consensus rating from Thomson Reuters Datastream. I usually use 2.5 as a cut off as it is halfway between an outperform (2) and a hold (3). I focus on the largest companies by market capitalisation that meet this criterion.

The table below contains much of the information I use in stock selection. There are 10 stocks in the ASX100 assigned to the Engery sector. However, I use my own filters to exclude stocks I don’t want to include – as I discussed at the start of my contributions.

In my opinion, WorleyParsons (WOR) is better thought of as a mining services company and so I assign it to the Industrials sector. Similarly, I assign Caltex (CTX) to that same sector as it is a refiner/distributor rather than a ‘resource’ stock. I exclude Paladin (PDN) because I feel the future of the uranium stock is heavily influenced by changes in the political landscape. That leaves seven stocks to chose from.

The top three companies by size – Woodside Petroleum (WPL), Origin (ORG) and Santos (STO) – each have strong ratings (2.2, 2.2,1.9, respectively) with a sufficient number of brokers contributing to those ratings (17, 15, 16). If I wanted to be a bit more adventurous I might consider looking at the stock with the best rating, Whitehaven (WHC), which is rated 1.7 (remember, a rating of 1 represents a buy). However, I note this company is experiencing a lot of takeover talk in the media and has a forward price to earnings (P/E) ratio of 40.7 – well above the average for the sector. This company could turn out to be a great buy, but my assessment is that there are additional risks that I would not wish to accept.

Santos, Woodside and Origin

I happen to hold WPL and STO and not ORG. At the time I first bought my energy stocks, STO had a much better rating than ORG, which swayed me. But these ratings change over time, as can be seen in Figure 1, which shows the ratings for the past 12 months. WPL and ORG currently have a similar rating, but WPL’s rating has typically been worse in the last 12 months. However, WPL is the biggest company by far, making up about 30% of the Energy sector in the ASX200. STO currently has a better ranking but, importantly, STO’s ranking has been improving while ORG’s has been deteriorating a little. My current preference between the two is still for STO.

If I determined that I needed some energy stocks, I need to know if it is a good time to buy. My updated Energy 12-month forecast of capital gains (from the previous issue) is for 8.9% against an ASX200 forecast 11.8%.

Finally, I have the sector as being a little bit cheap from the Exuberance chart in Figure 2. Exuberance is an attempt to measure market and sector mispricing. In the last year or two, the Energy sector has rarely been overpriced. This chart, and similar ones for the other sectors are updated each week on www.woodhall.com.au.

The bottom line

The current price of WPL is $34.22, well below the median target price of $41.95, but the lowest target price – $29.73 – is below the stock’s current price. On the other hand, for STO, even the lower price target, which is $12.00, is above the current price of $11.37. Forecast dividend yields of WPL (4.2%) and STO (2.7%) are reasonable for resource stocks in my opinion.

Of course, all of the information used in this report can change on a daily basis and it often does. Also, other factors might be considered – such company’s outlook statements – before selecting stocks.

And perhaps I can remind readers that the rules for selling or rotating stocks are, for me, different from those I use to buy.

Note: the estimates in the Figure are current to the close of business 5th November 2012. They are based on Thomson Reuters Datastream. Please go to www.woodhall.com.au for more information on the assumptions behind the estimates.

Ron Bewley is the Executive Director Woodhall Investment Research.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report

Also from this edition

View More Articles