Rising Star Buy: A Basket of Energy Stocks

This article is part of our Rising Star Portfolios series.

There aren't too many people out there who actually think the demand for oil is going to dry up anytime soon. If you're one of those people, then this article is probably not for you.

However, if you believe like I do that rising oil and gas prices will continue into the near and distant future, then having a basket of energy stocks in your portfolio is a great way to play the rising tide. In fact, the Energy Information Administration is forecasting 2011 oil prices to average $93 per barrel, $14 more than last year. Prices, according to the EIA, should top out close to $100 by 2012. As demand continues and the incentive for energy companies to add reserves intensifies, oil companies in all facets of the game should stand to benefit. That's why I'm adding a $2,000 position that includes four energy companies to my Motley Fool real-money portfolio.

Buy Recommendation: Petrobras (NYSE: PBR  )
Petrobras is a Brazilian integrated energy company that participates in the exploration, drilling, production, and refinement of both oil and gas. It has a near-monopoly in its home country and has significant reserves in the Campos and Santos basins, which together cover more than 100 million acres of land.

Petrobras has the potential to double its resource base in the next decade because of its large pre-salt reserves and more importantly, it has the knowledge and expertise to extract those resources. It's been operating in offshore Brazil for more than 40 years and is a global leader in deepwater drilling.

The company pays a nice 3.6% dividend yield (higher than competitor ExxonMobil (NYSE: XOM  ) ) that is easily supported by its 35% payout ratio, and this dividend only stands to increase as the company throws off more and more cash flow from operations. Trading at a deeply discounted 10.4 price-to-earnings ratio, Petrobras is a great investment for someone looking to buy an integrated, international player with limited geopolitical risk and years of proficiency in its field.

Buy Recommendation: Schlumberger (NYSE: SLB  )
Schlumberger is another leader in its field -- oilfield services -- and is the largest as well. With a market cap greater than peers Halliburton and Baker Hughes, Schlumberger stands alone as the top firm in the services industry.

As demand for exploration and production increases, Schlumberger stands to benefit at home and significantly abroad. With international rig counts recently hitting an all-time high, Schlumberger will get more and more work as it already makes about 70% of its revenue abroad. It has an important presence in high-growth regions of the world such as Iraq, Mexico, and Russia and has the competitive advantage to be able to offer full services, from managing entire oil fields to drilling wells.

Although the company has seen a nice uptick in its share price over the past year, it still lags competitors such as Weatherford (NYSE: WFT  ) and Baker Hughes, leaving much room for capital appreciation in an industry that's ripe for rebound.

Buy Recommendation: Diamond Offshore Drilling (NYSE: DO  )
Diamond Offshore is an offshore international drilling company with more than 45 offshore rigs. Over the past year, its share price has taken a 27% beating, much worse than industry leader Transocean (NYSE: RIG  ) . And some of it has been for good reason -- Diamond has an old fleet and a lack of deepwater expertise, which cannot match that of Transocean. The company has continually underinvested in its fleet and finds itself in a position where it will be hard to win lucrative, deepwater contracts. I believe this to be a real threat. However, I also think that the company has been punished a bit more than it deserved to be.

First, its midwater rigs have been able to benefit immensely from a lack of deepwater rigs, and midwater day rates have been rising with more advanced rigs. Second, if the company decides to undertake an investment scheme that provides it with more advanced technology and more updated rigs, it all of a sudden can play much better with the big boys. Signs already indicate that the company understands this, as it recently ordered a new ultra-deepwater drillship that will be delivered in 2013. If it continues to play catch-up in an efficient manner, I believe Diamond has more upside potential than many of its competitors.

Buy Recommendation: El Paso (NYSE: EP  )
El Paso is an exploration and production company second, and a pipeline operator first. It has a coast-to-coast network of interstate gas pipelines in major basins in North America and Brazil. It acts as a toll operator and collects gobs of cash for transferring natural gas across the majority of the U.S.

The company has successfully shifted its E&P priorities in the last year toward oil as the current pricing advantages have dictated that it do so. It has three pipeline projects that are on schedule and expected to come in about 25% under budget. With an $8 billion backlog of pipeline projects coming into fruition in the next few years, the company has multiple opportunities to boost earnings.

This is a great company to add to the energy basket because its E&P unit obviously is at the whim of oil and gas prices. However, its pipeline operations collect revenues on demand or reservation charges, which are independent of commodity prices. This helps mitigate risks from supply and demand and ensures that the company will continue bringing in cash despite what happens in the commodity market.

The Foolish bottom line
Each of these companies should continue to see a rebound from a previously depressed market (due to the BP debacle) and a continued need and demand for oil and gas. As countries like China and India build out infrastructure and grow, the world will only see an uptick in demand for these resources, and the companies mentioned above are in a great position to profit from this trend.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Jordan DiPietro owns no shares mentioned above. Petroleo Brasileiro is a Motley Fool Income Investor selection. The Fool owns shares of ExxonMobil, Schlumberger, and Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (34)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 19, 2011, at 10:07 PM, Superdrol wrote:

    I've looked at Petrobras several times. How does the political environment in Brazil factor into your decision ?

  • Report this Comment On January 21, 2011, at 4:22 PM, dividendbuzz wrote:

    And where does the quoted 3.6% dividend yield for PBR come from? Motley Fool shows a 0.9% yield and Yahoo shows 0.4%. And there is probably a foreign tax dividend withholding as well? I agree that energy stocks should show nice growth in the next couple of years, but I like US based COP, MRO, and XOM which should give me plenty of play for energy. I will study the oil field services firms though, thanks, Buzz

  • Report this Comment On January 22, 2011, at 12:20 PM, TheDecider wrote:

    SLB is overpriced compared to other oil service companies. I think investors will be better off with smaller competitors trading at much lower multiples, ATW for example.

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