TICKERS: ARD, ASH, CVX, COP, XOM, FTEK, , MEOH; MX; METHANEX, PUDA, SD, XTO
Frank Curzio: Size Matters
Source: Brian Sylvester of The Energy Report (10/21/10)
Frank Curzio may focus on small-cap companies, but the Penny Stock Specialist editor understands the importance of a big-picture view when it comes to investments of any size. In this exclusive interview with The Energy Report, Frank presents some promising oil, natural gas and coal stocks with caveat emptor—"volatile markets demand extra attention."
Frank Curzio: I specialize in small-cap stocks, but it's very important to look at the big picture—the macro view—to get a good read on smaller companies. For example, most analysts are now lowering estimates on Exxon due to lower natural gas prices following its recent acquisition of XTO Energy Inc. (NYSE:XTO). We have an enormous amount of natural gas in the U.S.—enough to supply consumers for more than 100 years. And producers continue to drill. Just knowing that information through looking at some larger-cap companies makes me a little nervous recommending smaller-cap natural gas companies. As for Exxon, it's trading over 10 times next year's earnings—a little more than 2% yield. I'd rather buy Chevron Corporation (NYSE:CVX) or ConocoPhillips (NYSE:COP). They trade at a lower multiple, pay a higher yield and, actually, are growing faster than Exxon.
TER: Speaking of Chevron, its margins are pretty substantial with oil around $80/barrel. It's going to use some money to buy back shares starting in the fourth quarter. Chevron's one of a number of companies that has announced stock-repurchase programs in recent months. Do these buyback programs form an investment thesis among oil companies?
FC: Not for all oil companies. Exxon buys stock back every single quarter. In fact, it bought back $8 billion worth when the stock traded at $95, which was its all-time high in 2008. Some companies announce buybacks and don't follow through on them. Companies also use those buybacks to enhance earnings. For example, Exxon's buybacks last quarter was one reason the company beat analysts' estimates. Chevron is announcing a new buyback. So, I think that's a good thing. I think management has this one right and I think Chevron's cheap. Hopefully, management will buy some of that stock down at these levels.
However, I'd rather see oil companies use cash to raise their dividends, especially if I'm a shareholder because that's what The Street is craving. That's why Microsoft jumped on rumors about its special dividend. The market's really craving yields right now. Instead of buybacks, which can be announced and take place anytime over a two-year span—and sometimes just expire—I'd rather see companies increase the dividend. That has an immediate impact on the stock. As a shareholder, you'll probably see a lot of those energy companies go higher if they raise dividends.
TER: Are there some names out there that recently upped their dividends that you believe are better buys as a result?
FC: They're not necessarily better buys. I think the valuations will stay the same but interest rates are very low right now. It's very difficult to find yield. For retiring people, it's one of the most difficult environments ever. I'm more of a younger guy, so it doesn't really hurt me as much. So, from a stock point of view, it's not necessarily that the fundamentals are going to be that much better; but I think the multiples will go higher. And they'll deserve that higher multiple because there's a lot of cash—particularly in the bond market right now that wants to come into the stock market.
You're going to see dividend yields rise and money will flow into some of these stocks. Again, Microsoft is a good example. A lot of the staples continue to raise their dividends even though their margins aren't as high. You see them raise those dividends, and money is flowing into these stocks. So, from a valuation standpoint, it's not so much that investors are saying: "Hey, I want to invest in that." But you're going to see the stock move higher because people are just craving yields and they're willing to pay up for those yields.
TER: Are there some oil and gas (O&G) names that have started a dividend or upped dividends?
FC: Other than Chevron, we've seen a lot of large-cap oil companies buy back stock for a while now. But you're going to see that from a lot of the large caps. The mid caps are really focused on growth, so they're putting their money into more exploration. So, from a large-cap perspective, it's Chevron, Conoco and Exxon; but again, Exxon's been doing this for a while. And I really wouldn't use that as an indicator to buy Exxon.
TER: Oil's down to $80/barrel today, and $80 oil isn't overly flashy. It is, however, providing healthy margins for low-cost producers and relatively good margins even for mid- to high-cost producers. What sort of general oil investing advice are you giving your readers right now?
FC: Oil provided healthy margins at more than $80/barrel; we'll see if it can resume—and maintain—those levels after China's interest-rate hike yesterday. Again, it's a question of how long we can stay there. Fundamentally, we're seeing drawdowns in inventory based on the latest data. That's a positive. And strong manufacturing data from the U.S. and China—the two biggest oil-consuming nations—is another positive.
High oil prices don't matter if the dollar rises. The USD has been collapsing from quantitative easing 2 (QE2). I think the government's going to come in with more, which is why we were seeing a real surge in commodities. But the USD gained on China's rate move, so we're now seeing an oil price pullback off prior eight-week highs. Investors should definitely pay attention to the dollar.
TER: So, you're saying a high dollar means higher costs.
FC: No, not higher costs. A higher dollar is not good for commodities in terms of price movement. When the dollar rebounds, you see commodities come down, as we've just seen with China's rate hike. Prior to that, commodities were on fire with gold reaching new all-time highs repeatedly over the course of a few weeks, silver hitting a 30-year high and copper really surging. You saw that push oil higher, too. It had really moved up over the last several weeks before China upped interest rates, which drove oil prices down 2% yesterday. So, again, I'd definitely pay attention to the dollar.
TER: Can you give us a few exploration and production (E&P) names you're following in Penny Stock Specialist currently?
FC: Sure. One company, Magellan Petroleum Corp. (NYSE:MPET), is a small oil and gas play with a market cap of about $100 million (M), $33M and no debt. It's nice to see a micro-cap O&G company that has very little debt and a lot of cash.
Bill Hastings is the CEO. He took the job in 2008 and, since then, the stock's been on fire. Bill is a 30-year veteran of the industry who's led oil teams of more than 1,000 people. He can work anywhere he wants and make a ton of money. But he decided to become CEO of this tiny oil company. When I met him at a meeting, I asked him why, because I'm familiar with this company. My late dad followed the company for about 20 years as a portfolio manager. His name was also Frank Curzio. He was on CNBC and quoted often in major financial newspapers. When I asked Bill why he took the company over, he said his dream was to start an oil company from the bottom and build it up into a mid-cap company. It's something I love to hear, because he wasn't just there for the money—he was there for the long term.
As soon as Bill became CEO, he decided to sell non-core assets and put his cash to work buying properties in Montana and the Bakken Shale. Magellan also signed an agreement with the largest methanol producer in the world—Methanex Corp. (NASDAQ:MEOH; TSX:MX; SSE:METHANEX)—to operate an Australian plant to supply China with methanol. So, it's a long-term plan that won't materialize for another two to four years. But I really like the direction in which the company is going. From a fundamental point of view, I believe Magellan is worth more than $4 based on its assets, cash on hand and gas sold to its customers. I would buy it under $2/share; today it's trading around $1.98.
TER: In your newsletter, you likened Bill Hastings taking this position to that of the Yankees' starting shortstop going into the minors.
FC: Yes. Though I've been familiar with Magellan for a long time, it really had been off my radar up until the point I saw Bill come to the company. So, I did a little research and discovered the guy had been in the business for 30 years. When you're in the oil business for 30 years, you can work behind a desk for any oil major you want and make a high, six-figure salary. This guy is getting his hands dirty again going with this small cap. He's a humble guy, a good CEO and he reports news whether it's good or bad. I love that. We have clarity on the company, something we didn't have in the past.
TER: What's the catalyst for growth?
FC: I base its catalyst for growth on the simple fact that it's the Bakken Shale—one of the large shale areas. A lot of the large caps are getting in. Longer term, Magellan plans on selling to China, which is a huge market for methanol. And the plant's Australian location provides a direct route to China, which is great.
TER: What other E&Ps do you like?
FC: Another company, SandRidge Energy, Inc. (NYSE:SD), which has been all over the place, just announced a takeover that pushed the stock down a lot; but the stock's come roaring back. I believe it was trading at $35/share not long ago, and it went all the way down to $4. Now, it's about up to $6. It's a great play due to its Arena Resources Inc. (NYSE:ARD) takeover, which will provide two revenue streams from natural gas and oil. And its high debt position won't be a concern going forward. I like the company and think it can turn around. SandRidge reminds me of Ashland Inc. (NYSE:ASH), a chemical company that really got beat up in late 2008. It went from $50/share to $7, and then $6 after announcing a major acquisition. We were able to pick it up when it went all the way down to $5. It was risky at the time but had no short-term debt concerns. Once the synergies of this deal are realized, the stock is going to take off. Today it's $50.
TER: Something you do that many analysts are hesitant about is cover companies that operate in China, some of which list in the U.S. but are primarily China-based. How do you determine which of these companies to write about?
FC: I just came back from a 10-day trip to China in August where I visited all the usual places—Hong Kong, Shanghai and Beijing; but I wanted to get a better picture of China, so I visited Shenzhen and Xian. I can tell you firsthand that the growth there is absolutely phenomenal. Wages are rising and jobs aren't leaving China—they're moving inland. That's creating a rising middle class and a huge wave of construction wherein builders work around the clock. So, I think you should have exposure to that economy.
In terms of finding stocks there, you really have to be careful in the small-cap space. China is a conservative nation that's not nearly as leveraged as the U.S. So you're going to see strong balance sheets for most of these companies. But I want to see strong growth on both the top and bottom line. Where possible, I want to see the insider buying that reduces downside risk (if key insiders are buying at current levels). I also look for experienced management—that's where I start. China is a much different economy; it's kind of like the U.S. in the '40s and '50s.
TER: But are you looking for a certain multiple threshold? Are you looking for cash flow?
FC: Well, you're going to see strong cash flow and fundamentals. Many Chinese companies have these qualities. But I think you have to look a little deeper to ascertain where else the company has exposure. You have to look at what's driving its growth (e.g., stock price moves over the prior 12 months) to see where it went down. You're not going to see charts that go straight up over those 12 months. Small caps, particularly, are all over the place. If you see the stock rise or fall 20%, find out why. Is it because of earnings? If it is, you can go back to the earnings conference call on the company's website to identify what investors want to see in the company.
With Chinese companies, you really have to go that extra mile. You can access free conference call transcripts on Reuters and other sites. But you really have to do a little bit more digging; the fundamentals are positive, so you need to make sure they're as accurate as possible. Hopefully, you can find a company that is audited by one of the Big 4 firms. Some are; some aren't. Those are the steps I take to determine if a company's share price can go a lot higher.
TER: What about oil versus gas in China? Natural gas prices are certainly higher there. But there's not enough to go around, so it's importing liquefied natural gas (LNG). Is that a game changer for Chinese and American O&G plays?
FC: It does change the game a little bit. I would go into the natural gas sector in China quicker than I would here in the U.S. because we have a ton of supply. But I really look at fundamentals.
TER: What are some Chinese companies that you like?
FC: One company I really like is called Puda Coal Inc. (AMEX:PUDA). China uses massive amounts of coal; in fact, coal provides more than 70% of China's energy needs. I'm sure many of your readers know that about China, but what they don't know is that China sees more mining deaths than any other place in the world. Most of these deaths come from small mines operated by underground millionaires who don't bother with safety inspections.
The government is cracking down on these small coal mines by forcing sales of their mines to larger players. The government calls these companies "consolidators," of which Puda Coal is one. It's able to buy these mines at $0.30 on the dollar. Earnings from these mines won't hit Puda's bottom line for another six to nine months. In the meantime, Puda's normal coal-washing operations are on fire. The company beat its last-quarter earnings by about 50%. And, over the last 12 months, Puda was able to generate $260M in sales from its coal-washing business alone. Going forward, half of its revenues will come from coal mining—which provides much, much higher profit margins. Puda Coal is an incredible, under-the-radar play; and I think its earnings will more than double once mining operations are up and running next year.
TER: That's fantastic. What about some other Chinese plays?
FC: One company I like is Fuel Tech, Inc. (NASDAQ:FTEK), which makes fuel technology to reduce emissions in its coal-fired plants. The company has small operations in China that are expanding rapidly. Its earnings last quarter were very strong; Fuel Tech is a great company, and it's been doing quite well lately.
TER: Do you have some parting thoughts on the oil and gas sector in general?
FC: I mentioned a lot of companies today. Investors just need to be patient with entry points. When the S&P 500 goes down 6% in August and up 8%–9% in September, you're going to see massive fluctuations no matter what a stock's fundamentals look like. So, if you're going to buy a lot of these stocks, definitely use stop losses and be patient on your entries. You might not see wide fluctuations in the large-cap space, but small caps could see 15%–20% price movements over the next 12 to 18 months. Be patient, and scale into these positions.
Frank Curzio is the editor of Penny Stock Specialist—an investment advisory that focuses on stocks trading under $10—and its exclusive Phase 1 Investor advisory. With more than 15 years of investing experience, Frank is the latest addition to the Stansberry and Associates team.
Before joining Stansberry, Frank wrote a newsletter on under-$10 stocks for The Street. He's also been a guest on various programs, including Fox Business News and CNBC's The Kudlow Report and The Call and is a featured guest on CNN Radio. He's also been quoted in financial publications—both online and off—and has enjoyed numerous mentions on Jim Cramer's Mad Money. Frank's "S&A Investor Radio" is one of the most widely followed financial broadcasts in the country, and his investment strategies—value, growth, top-down and technical analysis—have regularly produced 200%–500% winners for his subscribers over the past 15 years.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Frank Curzio: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.