After Memorial Day, what now?

Tony Crowell — Tue, 26 May 2009 23:45:31 +0000

After Memorial Day, stocks greeted the beginning of the summer trading sessions with a strong rally. Buyers ignored a gloomy housing report and the imminent bankruptcy of General Motors, focusing on a report of improved consumer confidence. Such mixed economic news will continue; the willingness to focus on the brighter side is increasing.
This measured optimism is likely to persist. Housing and employment are dragging on the economy but eased interest rates and fiscal stimulus programs will encourage their inevitable improvement. There are over three months of summer ahead before the stock market returns to its usually more active months. These summer months seem currently postured for continuing evaporation of last year’s panicked fears amid a slow rebuilding of confidence.
Gas pump prices are a prominent example of the impact of attitude on economics. Crude is trading above $60 a barrel, well below last year’s peak near $150 but up from $35 earlier this year. This rise might seem curious in view of global demand off about 3%, setting up two consecutive years of declining world demand for the first time in twenty years.
Oil inventories are the highest since 1993 but oil futures suggest that traders see even higher prices later this year. Production eased as the global economy sagged; oil industry leaders worry that exploration cutbacks foreshadow another oil spike when the global economy recovers. The recent softening in oil prices was probably only a pause in a supercycle of rising demand from developing nations confronting a supply situation with most of the world’s most extractable oil supplies have either exhausted or closed off to foreign investment.

Declining production coupled with a prospective return to increasing demand guarantees higher energy prices. Priced in dollars, these will get an extra boost whenever the dollar begins to weaken. Alternative energy and related stock prices will also regain support. The Saudi oil minister noted recently that lower oil prices always lead to subsequent price jumps after a period of underinvestment. He also predicted a price rise in the $75-$80 range.
The timing of these increases is more uncertain than their inevitability. For portfolio management, it seems sensible to build and hold a solid core of stocks keyed to a continuing long-term increase in energy costs. My top recommendations for several weeks have been XTO Energy (XTO-$41) in domestic natural gas and Flowserve (FLS-$71) in oil service equipment.
Occidental (OXY-$63), Statoil (STO-$20) and Petrobras (PBR-$42) have proven their ability to find and extract oil and gas in difficult places. Transocean (RIG-$75) and Schlumberger (SLB-$54) are the leaders in oilfield service although the current downturn in investment will subdue their earnings for a couple of quarters.
Noble Energy (NE-$31) is an exceptionally well-priced addition. This Texas-based offshore driller currently has 63 rigs working in the Gulf of Mexico, the Arabian Gulf, the North Sea and Asia. Analysts forecast 2009 earnings in excess of $6.00 a share, a P/E ratio of only 5. Management is conservative by industry standards with a relatively restrained long-term indebtedness of $750 million and sales of $3.5 billion, growing at 28%.
Petrochina (PTR-$109), which we sold two years ago at over twice its current price, deserves a renewed look. Backed by the Chinese government, it is expanding aggressively. This accounts for its somewhat pricey valuation, as its 2009 earnings will be about the same as Noble’s. It is an interesting play on both China and energy prices as is CNOOC (CEO-$124). Both have 4% yields.
Income investors should continue to consider Permian Basin Royalty Trust (PBT-$10). This provides monthly payments from established fields in western Texas. They vary widely with the price of oil but currently yield 6% with prospects of price increases. Nordic American (NAT-$33) is a well-run owner of 16 modern supertankers, up from 3 in 2004. It has an even more variable yield that usually ends up in double digits. It just completed another public offering that further strengthens its finances.

Crowell Roberts Investment Blog » Flowserve (FLS)

After Memorial Day, what now?