Energy Stocks To Pump Up Your Portfolio

Is it time, at last, to buy energy stocks? For the past decade, they've been badly depressed, victim to ample supplies that have kept oil sloshing back and forth between $14 and $22 a barrel, compared with $40 to $50 during its heyday in the early 1980s. But now, as industrialized economies recover and developing nations build advanced infrastructures, some pros see exciting potential in oil and gas issues. "Energy is directly tied to developing countries that are becoming industrialized," says Jeanne Mockard, manager of Boston's Putnam Natural Resources Trust mutual fund. Countries in Asia, the Pacific Rim, and Latin America all need energy to grow, while demand should increase as recoveries continue in Japan, Europe, and the U.S.

BELT-TIGHTENING. For years, bulls have been predicting an energy comeback--without success. The case is still not ironclad. Supplies of crude from Iraq will start flowing again soon, and technology has made finding and pumping new reserves easier than ever. But a number of factors are combining to support the prospect of higher prices. Not surprisingly, it's a story of scarcer supply and growing demand. To cope with tighter budgets, companies have curtailed exploration and drilling, which means a dearth of new energy sources. And it takes about five years to bring new capacity on-line.

In the meantime, many countries are pulling out of a worldwide recession. Although no one expects energy prices to take off, worldwide demand should rise slowly but steadily at 2% a year for oil and 3% for gas. Oil prices in the U.S. should move from $17.25 a barrel this year to $21 in 1996 and gas prices from $1.82 to $2.05, says Charles Maxwell, vice-chairman and managing director at C.J. Lawrence.

This could spell a profit gain for the major oil companies of 15% in 1995 and 20% in 1996, Maxwell says. "We think the price of oil, for the first time in 14 years, will be rising faster than inflation, but only modestly." Ernst Von Metzsch, who manages the top-performing Vanguard Specialized Energy fund, recommends putting 10% to 20% of your assets into such investments. Energy stocks are volatile, but ironically, they can steady your portfolio. That's because they do well when inflation is up, while other securities usually wilt. Utilities, however, stand to suffer from rising energy prices because they rely on oil and gas. And there is often a regulatory lag before they can pass on higher costs to consumers.

"UPWARD COURSE." So where do the pros see the biggest growth in the oil patch? For stability and dividends, albeit with slow-growing profits, look to majors such as Unocal and Mobil Oil. "They have good value as defined by low price-to-cash-flow ratios," says Maxwell. "They're well-positioned to grow long-term, and have strong earnings momentum on an upward course."

Unocal is especially intriguing. With natural-gas and geothermal operations in Thailand and Vietnam, it could fill the great demand expected from expanding economies in Southeast Asia. Like most other energy companies, Unocal is still downsizing. But with a price-to-cash-flow ratio of 5.3, it's slightly cheaper than most majors, which average 6.0 to 7.0. (Cash flow is commonly used to value oil companies because huge write-offs due to depletion ef reserves can distort earnings. But earnings are applicable to value oil-field-service companies.) Unocal's cash flow per share should rise from $5.40 to $6.50 in 1995.

Royal Dutch/Shell Group and Mobil are less dramatic but safer. Both are extremely well-run companies known for intelligent, farsighted management. "If you want to put your money away for 10 years and not look at it, buy Royal Dutch," says Scott Black, president of investment adviser Delphi Management in Boston. Royal Dutch is in every major field in the world, refines more than 3 million barrels a day--and has a balance sheet bigger than the gross national product of many countries. Its stock is trading near the top of its range, at 1131/2. But Von Metzsch thinks it will rise to 125 next year.

LEADING EDGE. Mobil is very big in foreign gas and is finding more oil abroad. Experts say that's where oil's future lies--since the U.S. market is so mature. Mobil has good relations with the Saudis and joint ventures in the Middle East. It's not cheap, selling close to its 87 annual high, but cash flow per share are expected to rise from $13.54 to $14.23 next year.

If you can handle more risk, oil-service companies--which make drilling equipment, build rigs, and do exploration research--have more growth potential than the integrated oil-and-gas majors. After 12 years of crash dieting, these companies are particularly lean and mean, says Maxwell. "They can take those revenue increases and turn them into spectacular gains."

Picks include industry leaders such as Baker Hughes and Schlumberger. Both are restructuring, are major suppliers to the natural-gas industry, and service oil companies abroad. They are at the cutting edge of technology: Three-dimensional seismic equipment are now better able to find reserves under the ocean floor and detect pockets of oil and gas in wells thought to be empty. Baker Hughes could jump from about 191/2 to 26 a share next year, with earnings up by 35 cents. Schlumberger's earnings per share should rise by 50 cents.

For speculators, volatile offshore rig companies could cough up the biggest rewards. That's because few new rigs are coming on line, and several are destroyed each year by the sea. As facilities dwindle, the amount that each rig has to produce must increase. "If you use 80% to 82% of capacity, the rigs break even," says Maxwell. But as production nears 90%, rigs rake in big bucks. Maxwell likes Reading & Bates, Sonat Offshore, Energy Service, and Global Marine. He expects growth for these companies to be around 20% in 1995, and 30% to 40% in 1996.

Vanguard's Von Metzsch is buying up debt-laden domestic independent companies that many analysts think are losers. USX-Marathon, Maxus Energy, and Oryx Energy were sold off when natural-gas prices fell off their two-year climb recently. That makes these stocks desirable to Von

Metzsch, even though some are losing money, because he expects their valuations to "improve markedly when it's recognized that oil and gas prices are trending up."

Marathon has good prospects in the North Sea and the Gulf of Mexico, he says, and cash flow per share should rise 70 cents next year, while the company's stock could jump from 18 to 24. Maxus, meanwhile, is seen as having weak management, which has been unable to make cost-cutting pay off. But Von Metzsch thinks a strong bias toward oil production will help if prices rise. He expects cash flow per share to rise 50 cents next year, and the stock to jump from 43/4 to 8. Earnings should rise $2 at Oryx, and the stock should go from 15 to 25.

RISING RETURNS. Of the eight or so natural-resource mutual funds that focus on oil and gas, Jay Schabacker, publisher of Mutual Fund Investing, is recommending Vanguard Specialized Energy, Fidelity Select Energy, and Invesco Strategic Energy. The energy funds group, which has trailed the Standard & Poor's 500-stock index by almost four percentage points a year for the past five years, is finally beating it, up 3.93% this year, compared with a 0.22% decline for the S&P. The total return for Vanguard, which has led the pack for the past five years, has risen 7.65% year to date, vs. 6.57% for State Street Research Global Energy funds and 6.44% for Fidelity Select Energy.

Fidelity fund manager Robert Bertelson is seeking companies that can boost production, such as British Petroleum, Amerada Hess, and independent Canadian Natural Gas, while Vanguard's Von Metzsch wants companies other analysts eschew. "That's why we're buying them," he says. "Most of the people are usually wrong."

If the energy bulls are right this time, fuel could do more than warm your house and power your car. It could generate some cool cash for your portfolio.

      Company         Price   Price to    Comment
                      9/12/94 cash flow*
                        MAJOR COMPANIES
      MOBIL           81 3/4   6.4     Excellent management and good
                                       prospects in foreign oil and gas
      ROYAL DUTCH     111 7/8  7.7     Is in every major oil field, has
      PETROLEUM                        huge output and great managers
      UNOCAL          28 1/2   5.3     Well-positioned to serve developing
                                       economies in Southeast Asia
      MAXUS           4 7/8    6.7     Exploration and development
                                       company with holdings in Indonesia;
                                       burdened with debt
      ORYX            15       4.6     In Gulf of Mexico and North Sea;
                                       undergoing heavy restructuring
      USX-MARATHON    17 3/4   5.0     Integrated company with domestic
                                       refining and marketing; heavy debt
      BAKER HUGHES    19       30.16*  Top provider of drill equipment
                                       suffering a demand slump abroad
      SCHLUMBERGER    56 5/8   25.86*  World leader in drilling, exploration,
                                       and measurement services
      SONAT OFFSHORE  32 3/4   18.50*  Specializes in deep-water rigs;
                                       yields more but costs less than peers
      *A price-to-earnings ratio is used to value service companies           
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