Energy Expert's Takeover Targets

06/30/2014 10:00 am EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue is a leading expert on energy stocks and editor of Energy & Income Advisor. Here, he discusses the outlook for the energy sector and highlights a pair of stocks with takeover potential.

Steven Halpern:  Our guest today is Elliott Gue, an energy sector expert, and editor of Energy and Income Advisor.  Thanks for taking the time to join us today, Elliott.

Elliott Gue:  Well, thanks for having me.

Steven Halpern:  Before we look at some specific stocks, could you share your general outlook for the energy sector and, perhaps, touch on the impact of recent geopolitical events on the energy markets.

Elliott Gue:  Sure, absolutely.  I think energy markets are going to be in pretty good shape this year.  Oil prices, in particular, have been very strong in 2014 and I think that surprised a lot of people.  At the beginning of the year, I think a lot of people were looking for oil prices to come down.  

I think we're seeing a number of trends under way right now.  In the US, we're seeing continued very strong production of crude oil from shale plays around the country.  That would include plays like the Bakken Shale of North Dakota, Eagle Ford Shale in southern Texas, and that's helping to keep US crude oil prices at a pretty sizable discount to international benchmarks. 

However, we are seeing greater demand for oil around the world as the global economy perks up a little bit and, outside the US, we're seeing actually pretty constrained supply. 

The current situation in Iraq, where it is disrupting some crude oil production and that's helping to keep international crude oil prices, as measured by Brent  Crude Oil, pretty buoyant relative to US crude oil prices and I think that's, again, something you're going to see continue. 

It seems like every year at the beginning of the year, you have a lot of people projecting an increased supply of oil from around the world, pushing down oil prices.

But what always seems to happen is, every year there's a disruption somewhere and this year, with the geopolitical disruption in Iraq a couple years ago, it was in, just a few years ago, it was in places like Libya, but there have been a lot of outages around the world that are going to keep international oil prices relatively high. 

Natural gas, I think you're going to continue to see, in the US, natural gas prices remain pretty low in the $4 to $5 range per million BTUs, and, I think that, what we saw was strong natural gas prices in the first few months of the year as a result of very cold winter weather.  Now that we're entering summer months, gas demand is down and I think prices are going to remain pretty low, especially compared to the international levels.

Steven Halpern:  Now today we're going to talk about takeover targets in the energy sector and you've been very successful in identifying takeovers in the past, including Resirus, GEO Resources, Lufkin Industries, and, more recently, VPL Oil and Gas.  What attributes are you looking for when considering a potential takeover play?

Elliott Gue:  Well, there a number of different factors that I look at.  One, of course, is size.  Some of the smaller companies in my coverage universe that may only really have a couple of products or services that they offer.  They're typically more attractive takeover targets because a wider number of companies can actually afford to buy them. 

Another thing I look for, of course, is geographic positioning with respect, particularly, to producers.  You know if you're a company that's producing oil and natural gas, I like to look at where you're producing that oil or gas from, and, is that an area where we're seeing other companies taken over?

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An example, of course, the Bakken Shale region of North Dakota.  You know, that's been an area where we've seen a number of small producers acquired over the last few years. 

A number, of course, that I've recommended over the years, like Brigham Exploration, were acquired because they had acreage in the heart of that play and, in many cases, it may be actually cheaper for a larger company to go in and acquire acreage by buying a whole firm than going and trying to actually lease that acre, parcel by parcel.  So those are some of the things I look for. 

Another thing I like to look for, is companies that I think are undervalued.  In some cases, that could be because of poor management.  In other cases, it may be just because they don't have the scale to sell their products, say, internationally and, therefore, they could benefit from being acquired by a larger company with greater economies or scale on that end.

Steven Halpern:  Okay, so let's look first at Weatherford International (WFT).  What's the attraction of this oil services firm?

Elliott Gue:  Well, Weatherford is one of what we call the big four oil services firms, which would be Schlumberger is the largest, then you have Haliburton, Baker Hughes, and Weatherford.  Weatherford is the smallest of the big four.  It's also the cheapest on most valuation measures. 

It's trading at a pretty sizable valuation discount to an industry leader like Schlumberger or a name like Haliburton.  Partly, that's for a good reason.  Weatherford has been kind of a serial underperformer over the last few years, really up until 2014.  Partly as a result of some major management blunders over the years. 

Management, for example, in an effort to try to gain business in Mexico, massively underpriced the contract there just a few years ago.  Ended up losing a lot of money.  They made similar missteps in countries like Iraq and that's really hurt profitability. 

They also got, kind of, sideswiped by an accounting scandal which dragged on for two years and finally came to a resolution at the end of last year.  It was an international tax accounting scandal, which is a very complex area, but they clearly did not have strong enough controls over that part of their business to keep that from happening, and that pressured the stock for a couple of years. 

But, if we look beyond, sort of, the headline issues, you know, Weatherford has a lot of very high quality service lines in its portfolio.  The most important actually relates to a company you mentioned a while ago which was Lufkin Industries and it's called artificial lift.  Now artificial lift is, basically, a technique for producing more crude oil from very old oil fields. 

If you've ever flown say, to LAX, and looked down, in the Los Angeles area, you'll see a lot of these-what we call suck-a-rod pumps, that are pumping oil, pumping heavy oil from these very old oilfields that may have been in production for 100 years.

That's the kind of equipment that Weatherford makes.  That's in very, very high demand right now, partly because oil prices are so high and there are a lot of oil fields around the world which are becoming mature. 

They're old fields, they're not producing at their peak level, but you can see a pretty sizable production uplift by using artificial lifts.  Weatherford's a leader in this area.  Lufkin was the other major player in that area. 

Lufkin's already been acquired and, I think, that this particular asset could be very attractive to a bigger player like Schlumberger or Haliburton that wants to beef up their exposure to artificial lifts.

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Steven Halpern:  Now, you've also highlighted a company called Alon USA Partners, a limited partnership that owns refineries.  What's the story with this company?

Elliott Gue:  Yeah, we have, actually, a couple of companies bearing that name.  We have Alon USA Energy which is a normal corporation trading under the symbol ALJ, and then you have an MLP that they formed which is Alon USA Partners which is symbol ALDW

Basically, what they did when they formed the partnership is they sold one of their refineries or they spun off one of their refineries into that partnership back to an oil refinery located in Big Springs, Texas, which is near Midland, Texas. 

Basically, they're benefiting from very low oil prices in the Permian Basin area of West Texas and, as a result, they're able to buy crude oil feed stock at a discount and sell gasoline and diesel fuel at high prices and earn a nice spread and this partnership pays out virtually all of its cash flow to unit holders as distributions on a quarterly basis.  Right now, it's yielding about 16%.

 What I see, though, is really the takeover side of the equation, I think is going to come in more at the parent level, and that would be Alon USA Energy.  They own a secular refinery in Louisiana, the Krotz Springs Refinery.  I think that, eventually, they could try to sell that asset to the MLP as well. 

The reason they didn't in the beginning is, historically, it's had pretty volatile profit margins because it refines crude oil near the gulf coast where prices have typically been much higher than in West Texas but that's starting to change. 

We're seeing a lot of oil from places like the Bakken Shale, the U Ford Shale, find its way to the gulf coast and that may actually make that refinery more attractive to sell. 

The other thing Alon USA has is they have a large network of other types of oil-related assets.  They have some old refineries in the Los Angeles area, which probably aren't useful as refineries any more or not profitably-run as refineries anymore, but they're areas that you could build or use tanks and storage facilities that are already there and which are in very high demand. 

The other thing they're talking about doing is building out a rail facility in Southern California, which would allow oil to be actually transported by rail in from other parts of the country to Southern California.

Oil prices there are much, much higher than anywhere else, virtually, anywhere else around the US, because there's not enough pipeline capacity into that region, so I think that they could actually build out those assets a little bit and those would be very attractive as a sale, as an acquisition target. 

The third thing they have is a number of convenience stores that sell gasoline and diesel fuel.  We've seen a couple of acquisitions in that area, the biggest being Energy Transfer Partners' recent acquisition of Susser Petroleum.

And there's retail convenience store locations, which, in this case, are mainly branded as 7-Elevens, could be an interesting acquisition candidate for a company that's interested in building out their retail distribution chain, so I think there are number of assets within that parent that could, individually, be acquisition targets. 

You might also see a bigger company buy the whole thing and then sell it off in pieces and I think they could realize a lot of value by doing that.

Steven Halpern:  Well, we really appreciate you taking the time to join us today.  Thank you.

Elliott Gue:  Thank you for having me.

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