Hedge Funds’ Energy Stock Picks

The energy sector is a minefield. There are those that predict that the world will see another oil shock by the end of 2013, as the natural gas boom is threatened by concerns over fracking. Then there are the issues related to American energy independence, a feat that will likely come only with some degree of concentration and the development of new energy technologies – both things that would most likely affect the bottom line of the energy sector as it currently stands. Regulation, whether it stems from fracking or otherwise, is also a major concern. Many say regulation is the primary reason why the US is still dependent on foreign energy, citing restrictions on drilling and environmental concerns. Leaving those political subjects to the side, what does this mean for investors putting their money in the energy sector?

Barry Rosenstein JANA PARTNERS

One person’s guess is as good as another’s at this point. Rather than try to guess, we like to look to hedge fund managers to see what they are investing in. Hedge funds report their activities every quarter, and sometimes more often if a trade is large enough to require it. As such, it is easy to follow along with their movements, even going so far as to monkey their largest positions. After all, stocks with a high amount of hedge fund investment tend to outperform those that don’t share the same support. Lately, hedge funds have been buying in the energy sector, and not just the big name oil companies like Chevron (CVX) and ConocoPhillips (COP) (we like both Chevron and ConocoPhillips as long-term investments and have a long position in COP). In fact, the trend seems to be largely focused on smaller energy companies.

Recently, Barry Rosenstein’s Jana Partners took a 5.5% stake in Marathon Petroleum Corp (MPC), a move which makes the fund the refiner’s biggest shareholder. It also has options in MPC, exercisable February 17, which would allow the fund to buy an additional 896,000 shares at $27.50 each. As of the open of trading on Tuesday, February 7, MPC was trading at $44.30 a share, with a mean one-year target estimate of $50.50 a share. Marathon Petroleum is an excellent long-term pick. The stock’s PE ratio is less than 9 and it is expected to increase its earnings by 28% annually over the next five years. If Wall Street projections turn out to be accurate, the stock should easily triple its value in 5 years.

Carl Icahn increased his fund’s investment in the energy sector recently. A couple weeks ago, the famed investor added 12.58 million shares of CVR Energy Inc. (CVI) to his portfolio, giving him a 14.54% activist stake in the company. CVI is priced at 8.36 times its forward earnings and 0.47 times its sales. The company has a price to book value of 2.20. Over the last 52 weeks, the stock’s price has gone up over 46%. Looking at its investor profile and its current pricing, CVI seems like a good deal. Almost 7% of the company is owned by insiders while financial institutions, like Icahn’s fund, hold another 86.50%, leaving just over 6.5% available for private investors. Higher volumes of insider and institutional investment tend to indicate strong investments, and the same is true here.

Ken Griffin’s Citadel Investment Group is also upping its energy game. It disclosed a 6.5% passive stake in Basic Energy Services Inc. (BAS) and a 5.4% passive stake in Ciena Corp (CIEN) in January. BAS is priced at 7.55 times its forward earnings. This small company (market cap under $800 million) as strong analyst support. Dahlman Rose upgraded the company from hold to buy on December 16. In fact, some say BAS, which opened trading on Tuesday, February 7 at $19.14 a share, could go as high as $36.00 a share in the next 12 months. CIEN is roughly twice the size of BAS, with a market cap of $1.58 billion. Over the last five years, CIEN’s EPS has grown at a rate of 97.48% per annum. Analysts predict the company’s EPS will grow 16.00% per annum over the next five years, outpacing industry expectations of 15.03% and market predictions of 10.74%. CIEN also has a high amount of insider and institutional interest, making it even more attractive. We are bullish about both CIEN and BAS.

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