While everyone else is getting ready for football season, Sean, Tyler and Taylor are drafting energy stocks this week with our first ever energy stock fantasy draft.

A full transcript follows the video.

 

Sean O'Reilly: It's the Industry Focus fantasy draft, on this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly at Fool headquarters in Alexandria, Virginia. Joining me for today's energy show are Tyler Crowe and Taylor Muckerman. How's it going guys? We missed you last week.

Tyler Crowe: Pretty good. Sorry we left you hanging there. I think we both had some out-of-town obligations.

O'Reilly: I literally could not find anybody, so I had one of our awesome Foolish contributors, Matt DiLallo, call in. We had a good chat.

Crowe: I listened to the show, it was a good show.

O'Reilly: A little bit of insider info: He lost reception so we had to restart the show on his cell phone.

Taylor Muckerman: You've got to do what you've got to do. You've got to bring the show to the people.

O'Reilly: You do. Without further ado... The NFL is having its opening game tonight [Thursday]. We're going to get into the spirit of the season by doing our own fantasy draft pick, but instead of picking players, we're going to be picking energy stocks. We'll have three rounds, we'll each pick a stock, and we'll go with that.

For the first round we're going to be picking our franchise tags. This is particularly poignant because the energy sector has been performing it seems like literally every stock is trading as a free agent. 

Crowe: So, my first pick of the 2015 energy draft: I'm going to go with Enterprise Products Partners (NYSE:EPD).

Muckerman: Off the board.

Crowe: They're one of the staple companies in the energy space, not a producer. Rather, it has the nation's largest network of natural gas liquids pipeline and infrastructure network. That's natural gas processing. Basically, what they do is take that in-between product, that natural gas and oil, and it's a major transportation network for that.

Some of the things you see out of that are like propane. It's also a major chemical feedstock for a lot of plastics and stuff like that. You can use some of it in heating, but it's not like the traditional natural gas that we see. If you look at the company over the past 10 to 15 years, it's one of the highest performers in the space in terms of total returns, which is a culmination of dividends and share price appreciation.

It's a master limited partnership that doesn't have a general partner, so it doesn't have those obligations to give out all the cash it needs to at any given moment. It stores a little bit for some organic growth, and if you look at the moves they've made in recent years, it's really hard to argue with them.

O'Reilly: This isn't the first time you've talked up this company. Is there anything...

Crowe: I've been hyping this company for years. I'm the hype man.

Muckerman: Little John for EPD.

O'Reilly: The idea for these first picks is kind of what stocks you would use to build a portfolio if you were building one today. Was there a reason this is your bedrock, or your base?

Crowe: One of the reasons for me that it's a base is the fact that it is isolated from commodity prices. I'm not going to get those wild swings. Especially somebody who's new to the energy sector, who may get nervous when you look at a cyclical industry and watch stocks drop 50% or 60% like we have seen over this past year.

Eighty-five percent of their gross margin -- revenue after cost of goods sold is 85% fee-based. Everything comes from toll booth models, so it really isolates them from that commodity price and generates a lot of cash for them, which they can return to shareholders. That's one of the reasons I think it's a great way for people to get into the energy sector for the first time, because it doesn't have those wild swings.

O'Reilly: Got it. Taylor, what's your pick?

Muckerman: I'm sticking with the same sector, same position, I guess: Spectra Energy (NYSE:SE). That's my bedrock. They're yielding 5.3% right now after the stock has been sold off. It's in a weak division. It's in the East Coast as far as distribution of natural gas is concerned. A lot of companies are focusing on the middle of the continent because that's where a lot of the natural gas and oil are produced.

You've got this company building out $35 billion worth of projects starting from 2013 and through the next few years. They have access to the entire East Coast, building out the New England area, which is lacking in natural gas infrastructure and they have solid coverage, solid distribution to that area. You're looking at a coverage ratio above 1.

I think they're on 1.7 right now, they know they can maintain 1.2, so you're not too worried about the dividend here. It's one of the largest companies in this space. That's my No. 1 pick.

Crowe: My only question for them is, when I look at these companies like a Spectra who have these giant backlogs of projects, someone in that same position is Williams, and one of the things I look at is whether or not they can access enough capital to get those things all on line.

Muckerman: That's fair.

Crowe: That's my biggest question with Spectra Energy.

Muckerman: There's a high rating on this company. They're looking at some decent credit form the banks, and right now only a few of these $35 billion worth of projects are actually under way. So they're not pot committed yet. They are doing their due diligence on about half of them, so they can pull back if they need to. I feel confident in this company's capability -- with their Spectra Energy partners in DCP Midstream, LPs below them to funnel cash upward. I like this company a lot.

O'Reilly: Cool. Spectra's off the board.

Muckerman: Spectra is off the board.

O'Reilly: My bedrock pick for my franchise tag is EOG Resources (NYSE:EOG). The reason being that they are the strongest shale operator there is; Capital IQ still anticipates them growing earnings out to the end of the decade through a combination of increased efficiency; they're getting better returns at $65 oil than they were at $95 in 2012. Taylor, I think you're also a fan of this company. I'm interested to see why you went with Spectra over an EOG, or someone like that; but they're my bedrock for starting an energy portfolio today.

Muckerman: I went with -- I think it's a more solid footing. You're going to see a huge potential upside with EOG. I think Spectra might have a bit more guaranteed week-to-week returns. In fantasy drafter terms: "week to week returns" -- this would be more consistent year-over-year returns.

Crowe: I feel like you just drafted an injury-prone running back. Could score a lot of points... A cyclical company could really burn you on that one.

O'Reilly: EOG has not been injured for a while. Before we move on with all the rest of our draft picks, I want to make everybody aware of a very special offer for all of our Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.

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For round two of our fantasy energy stock draft picks, we've got our Hail Mary pick. Basically, these are stocks we were looking at that are Rule Breakers, or long-tail investments that will take years to develop. First up is Taylor. What have you got for us?

Muckerman: I'm going a little outside the energy spectrum, but I believe that energy is going to drive this company in the future. That's Silver Wheaton (NYSE:SLW). You hear the name and you think "silver miner," but it's a silver streamer. They don't have the overhead that a miner does. They're basically buying silver from base-metal producers that don't actually mine for silver -- so the copper miners, the gold miners, lead and iron ore miners; it's a byproduct of what they're actually mining.

They're yielding 1.7%, so it's a low yield, but it's a fluctuating yield, so you're not going to see a typical distribution, or dividend like you might with a miner. They're going to base their dividend on the previous 12 months of cash flow. Investors are going to be able to predict what's going to happen with the dividend.

I think it's one of the more unique dividend policies that I've ever seen. I spoke with [Silver Wheaton CEO] Randy Smallwood a couple of times over the last few years, and he's looking at solar, he's looking at batteries to drive growth here, and because the metal prices are so low right now there's not mining development.

You're looking at a potential huge shortfall in supply versus the demand as you see solar continue to ramp up like it is. Of course, batteries, since silver is a high-conductive material. I believe you're looking at about 70% of worldwide production that comes from by-product of production. Only 30% is actually coming from silver-specific mines. Silver Wheaton has tapped into that 70%, and they're the leading streamer in the world.

[Smallwood] says that production is going to drop this year from a peak in 2014, it will drop again next year, and there's going to be a pinch somewhere down the line. You've seen the share price crumble a bit lately because silver and gold -- which they're moving into a bit more -- have fallen pretty considerably over the last few years. I like this company long term because of the markets that they're addressing in terms of innovations.

O'Reilly: Cool.

Crowe: A quick question on this one, how you were saying 70% of it comes from secondary mining. It's not the primary thing you're looking for. With so many other mining sectors right now slowing down, like copper, iron ore -- does that slow down their ability to secure new sources of silver in the next couple of years? Could this be a company that you'd have to sit on for a couple years before it really starts to take off again in that commodity cycle?

Muckerman: They've had a few more mines that they've signed deals with to come on line. Right now they're, in his words, "done spending cash on new mines for the foreseeable future." Not because they're worried about the future of silver, but because they've reached a point where they now feel comfortable about the ramp-up in the mines that they're attached to.

They're comfortable with the next few years of growth in terms of the capex that are being poured into the mines from Goldcorp and Vale and other big producers of base metals. You're seeing this company not having to go out and spend the next couple of years, and I think their per-unit cost for silver-equivalent ounces is in the $4 range. That's mapped out to 2018. So if silver upticks any from where it is right now, the margins are going to continue to improve.

Crowe: I believe since I went first last time, you're up next for this one.

O'Reilly: This is my Hail Mary pick, and it's literally the best Hail Mary pass I could think of, which is Linn Energy (NASDAQ:LINE).

Crowe: You're going with the dirty, dirty value play for your Hail Mary play.

O'Reilly: They're down 90% over the last year. It's very sad, but they do have some of the best hedges around. I think we could all agree on that. It's a Hail Mary pass because if and when oil prices recover in the next year or two, they would survive and possibly come out on the other end of it OK. They're about 80% or 90% hedged on their production this year, and that tapers off next year at about two-thirds. Then they're in trouble in 2017. That's why it's the Hail Mary pass. They are one of the biggest MLPs. They recently cut their dividend to preserve cash, this is the...

Crowe: This is the "Buckle up, I really hope that oil prices increase."

O'Reilly: Let's lob this 80 yards and see what happens.

Crowe: I'm actually personally invested in Linn Energy, so you've got a fantasy draft...

O'Reilly: You're actually doing this.

Crowe: I am actually, definitely making the Hail Mary prayers on that one.

O'Reilly: Be strong.

Crowe: I guess I'm third. My Hail Mary pass is SolarCity (NASDAQ:SCTY). Not an oil pick.

O'Reilly: You been drinking the Rule Breakers Kool-Aid over here.

Crowe: Jim Chanos, the well-known short investor who just actually went short on SolarCity, had that house-of-cards model on its debt profile. However, when I look at this, here are some of the things I'm looking at from a long-tail perspective:

Yes, it's losing money today. Yes, it's still going to require an immense amount of funding to actually make that happen. However, the growth in the company has still been quite spectacular over these past couple years.

O'Reilly: They're growing faster than -- who's the other player?

Crowe: Vivint Solar. There's a couple others that are growing at pretty high clips. If you're looking at the raw number of growth, SolarCity is growing probably the fastest in terms of total megawatts deployed.

O'Reilly: Plus they have the whole "Elon Musk" association to give them a halo.

Crowe: That certainly gives them a little bit of assistance. The one thing that I keep coming back to with that idea that their debt is too much of an issue: You almost have to think of their debt similarly as you would think of a utility company. The debt that is being secured by SolarCity isn't like it's built on the company's solar panels.

Those debts are structured based on the contracts that people are going to be paying for their power. It's a power-purchasing agreement, very similar to a utility bill. If you look at those, utility bills and utility payments like water or electricity have some of the lowest default rates of any sort of debt payment in the world.

You're not as exposed to that credit risk. That's why SolarCity has been able to access such cheap capital. It looks at that and says, "That's a very secure payment." With that in mind, yes, it's growing a lot and it's still spending more money. However, once it gets to its target goals and slows down that growth and they're not spending as much on the deployment of new capital, all those accumulated contracts are going to turn into a cash flow generation.

When that happens, you've got the ability to hopefully even return a dividend if we're really ambitious, or you can actually internally fund growth and not have to access capital as much.

O'Reilly: Steady stream of cash flow at that point. It will be assigned a high multiple.

Crowe: Again, Hail Mary. That's the idea.

Muckerman: My second-round pick is clearly hoping for the success of SolarCity.

O'Reilly: Cool. For our third round, we're going to do our Waiver Wire picks. This is a company that you wouldn't build a portfolio around, but one that you could fill out a portfolio with today because of its valuation. I believe I get to go first now.

Crowe: You do.

O'Reilly: Tyler, you're going to appreciate this: I'm going with Harold Hamm's Continental Resources (NYSE:CLR).

Crowe: You just picked three producers right in a row. You're completely flapping in the wind when it comes to oil prices. You're very bullish on oil prices right now.

Muckerman: Going for broke.

O'Reilly: I look at supply and demand, baby. It's currently trading at...

Muckerman: You'll have a couple good years of a run.

O'Reilly: What time period are we looking at here? Three years? I don't know.

Muckerman: This is a dynasty league.

Crowe: Indiscriminate.

O'Reilly: Indiscriminate? Yeah. Continental is currently at $28 per share, and Hamm's easily the most entertaining oil CEO there is. High-profile billion-dollar divorce notwithstanding. They're aiming for cash flow neutrality until oil prices turn around. That's pretty much as good as you could hope for in an environment like the one we have today.

I was fiddling around with our friends over at S&P Capital IQ's analyst estimates, and analysts think that by the end of the decade they'll be back to earning about $4 a share through efficiency gains and a modest rebound in oil prices. That's OK by me, given that it's trading at $28 right now.

Crowe: When you've got companies in the North Dakota region...

O'Reilly: And they're the biggest in North Dakota.

Crowe: That's their bread and butter. Some of them are getting breakeven at $30 right now. That's quite promising for the future.

O'Reilly: That could be worse.

Crowe: Who's up second? Is it me?

O'Reilly: Sure.

Muckerman: Why not?

Crowe: My Waiver Wire pick is Helmerich & Payne (NYSE:HP).

O'Reilly: You made that up.

Crowe: It's probably one that isn't brought up a lot when we talk about energy companies.

O'Reilly: I had them on my Foolish watchlist because I think we talked about them a month or two ago at the water cooler.

Crowe: Yes. Helmerich & Payne owns land rigs, mostly in the United States. There are a couple of overseas assets, but all of the drilling that goes on in the United States is rented out to land rigs, and if we look at the land drilling space in the United States today, they need those new, high-technology rigs that have high horsepower, high torque, things like using AC power instead of DC -- which is something that was used 20 years ago -- able to drill horizontally.

Today, even the ability to move on the pad so you can drill 10 or 12 wells from a single spot at the same time. Helmerich & Payne has the largest fleet of these. With that, surprisingly unlike other companies in the space, it has done so without taking on a lot of debt. In fact, I believe it is net debt 0. I believe it actually has more cash than it actually has debt on the profile.

Even with rig counts down in the United States...

O'Reilly: That was going to be my question. Are all their rigs just sitting there now? The rig counts dropped by two-thirds.

Crowe: They have a pretty low utilization rate. However, even at this low utilization rate, they are still generating net income. They're still pretty cash flow positive and have that giant war chest of cash sitting and allowing them to ride out the storm much better than many of its peers. It has a history of holding, or raising, its dividend for more than 20 years now, and if you're looking at something stable in the oil business, that's hard to beat.

I'm looking at this and saying that it may not be the high-flying pick right now because land rigs are down, but based on its valuation and based on its ability to withstand the low oil prices, I'm really liking this stock right now.

All right, Mr. Muckerman. Finish us off, here.

Muckerman: OK. What is this, the Waiver Wire?

Crowe: Filling in week to week.

Muckerman: Who's my substitute here? I'm going with Devon Energy (NYSE:DVN). I'm going with my first producer. I'm looking at this company as a pro in terms of enhanced oil recovery: It's got good basin coverage with the Eagle Ford, the Permian, among others. Those are the two most popular that you might know of. It's getting into reusing a lot of its own energy to lower its costs.

It's still producing pretty well. They've increased production year over year in the latest quarter, it's pretty low-cost in terms of what you're seeing out there. Maybe not as low-cost as EOG in terms of per-barrel cost, but they're still competitive and they've been beaten up just as much as some of the worst producers in the business. I think this company could fill some nice holes.

O'Reilly: Cool. If you'd like to be a part of the fantasy energy stock draft, email us with the individual whose team you'd like to vote for. That would be #Tyler, #Taylor, or #Sean. We're not doing this on Twitter, though.

Muckerman: You could tweet @TMFEnergy if you want.

O'Reilly: That would work. Perfect. Just let us know who you'd like to vote for. If your team is winning at the end of the year, we'll send you some Motley Fool swag. I think we've got some hats and...

Crowe: We've got some stuff.

O'Reilly: Yeah. We've got T-shirts.

Crowe: At the end of the year we'll take all these picks and, starting at the market close today, we'll see who won at the end of the year and we'll do a random drawing from the people.

O'Reilly: You're going to keep track, right?

Crowe: I'll keep track.

Muckerman: Total return.

Crowe: Total return, dividend included.

O'Reilly: Excellent. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!

Taylor Muckerman owns shares of SolarCity and Spectra Energy. Tyler Crowe owns shares of Enterprise Products Partners, Linn Energy, LLC, and SolarCity. The Motley Fool owns and recommends SolarCity, Spectra Energy, and Twitter. The Motley Fool owns shares of Companhia Vale Ads, Devon Energy, EOG Resources, and Silver Wheaton. (USA). The Motley Fool recommends Enterprise Products Partners. 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.