Motivation enough to consider Energy sector investment

The week ended October 10, saw nine of the ten sectors that make up the NASDAQ index advance led by Energy stocks (+7.5%). If you might think this is just a very short rally then you are in for a surprise. Take a quick look at the sector indices performance on NYSE for holding periods, YTD, 1-Year, 3-Year, and 5-Year. NYSE Energy index leads in all these holding periods except in YTD even where it is not the laggard (see table 1 given below). This should be motivation enough to consider investment in Energy sector.

Intra sector stock picking

NYSE Energy index (NYSE) constitutes 146 companies with 114 based in the US based. Our first criterion would be to see if the top ten companies in NYSEE have enough steam to be selected as one of the seven bull stocks. Once the top ten companies in NYSEE are exhausted then we will consider other companies.

* PTR is part of NYSEE but not one among the top ten holdings in NYSEID

The company whose 1 year target price appreciation is in negative territory is automatically eliminated, i.e., ENI SpA is eliminated. Those companies whose YTD is in negative territory are also eliminated, i.e., Exxon Mobil Corp and ConocoPhillips are also eliminated. Now we are left with the seven bull stocks.

Why will the seven bull stocks outperform?

Those companies that outperform NYSE Energy index in both YTD and 1 Year period will automatically qualify as members of our 7 bull stocks. Consequently Occidental Petroleum Corp, and PetroChina Company Limited are automatically selected. These companies are likely to continue their good performance in the remainder of 2009 as well.

Justification for the other five stocks

Chevron (CVX) is the third-largest integrated oil company in the U.S. and the fifth-largest in the world--as well as the fifth-largest natural gas producer in North America. The company has a strong global presence in refining, marketing and transportation--with retail marketing under the Chevron, Texaco, and Caltex brands.

I believe Chevron will benefit from improved industry fundamentals and higher commodity prices through its exploration and production activities. With Gulf of Mexico oil and gas production being restored, and several upstream projects slated to start up, I expect Chevron's oil and gas production will increase about 4.1% in 2009, and I look for annual production growth of 2% to 3% between 2007 and 2012. I believe that the company's high degree of earnings and dividend growth and stability justifies a higher multiple than Chevron's stock currently receives in the market and that its shares are undervalued reflecting weakness in its upstream business. In addition, the shares recently had a dividend yield of about 4.0%.

Royal Dutch Shell PLC (RDC)

The company's business risk profile is excellent and its financial risk profile as minimal. The company is the second largest natural gas producer in the world and has led its super major peers in monetizing its substantial worldwide equity natural gas resource base by investing in liquefied natural gas (LNG) and Gas-to-Liquids (GtL) technologies. Royal Dutch Shell has emerged as a clear leader in the fast-growing LNG business.

BP PLC (BP)

BP p.l.c. is one of the largest listed oil & gas companies in the world. It is an upstream-focused, vertically integrated group, with a strong presence in the downstream sector. The company has a growing activity in gas and power and in solar power generation, which I view very positively.

Schlumberger Ltd (SLB)

The Houston-based oil-services firm helps customers—mostly major Big Oil firms, like Exxon Mobil—find and extract oil by setting up wells and maximizing their efficiency. About three-quarters of Schlumberger's $27 billion in annual sales come from outside the U.S. As oil companies must move farther offshore to meet the world's demand, Schlumberger maintains a technological edge over the competition in today's increasingly complex drilling environments. The company is active in deepwater operations in West Africa and also has a large presence in Russia.

Total SA (TOT)

Total has enormous amounts of refining capacity: Over 2.5 million barrels per day. In fact, it is the largest refiner in Western Europe. Even more important than Total's industry-leading refining capacity is its ability to produce unfathomable amounts of natural gas. Total has staggering amounts of production capacity. At current levels of demand, the company has more than enough supply. But when Moscow gets aggressive and closes its pipelines, European demand will go through the roof. That means Total's natural gas will sell for a premium.

Caution note

These stocks are my favorite 7 bull stocks in the energy sector. The only rider is that I have limited the stock universe to big market cap companies. From a portfolio construction (of course with in energy industry) point, these seven may not be the best combination. Moreover, I have not warned you on potential concerns regarding the performance of these companies. Still, I believe these companies are good from both fundamental and technical analysis.