Elliott Gue: Top Picks Update

07/18/2014 10:00 am EST


Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Each January, we ask the nation's top newsletter advisors for their favorite stocks for the new year. Now that we have reached mid-year, we are following up with some advisors whose performance was most noteworthy. Here, we speak with Elliott Gue, editor of Energy & Income Advisor.

Steven Halpern:  Our guest today is energy sector expert, Elliott Gue, Editor of Energy and Income Advisor.  How are you doing today, Elliott?

Elliott Gue:  Good.  Thanks for having me on.

Steven Halpern:  In our January top picks report, you chose two stocks from the energy sector; a conservative and a speculative favorite.  Now before we look at these individual picks which both did exceedingly well, could you first review the major factors that impacted the energy sector over the past six months and your outlook for the balance of the year?

Elliott Gue:  Well, we actually had a very strong commodity crisis in the first half of 2014, especially-at first it was in the natural gas sector.  We had obviously a very cold winter in parts of the US, and high heating demand pushed up the price of natural gas quite a bit. 

I think a lot of that is temporary now that we've seen temperatures obviously return to more normal levels and summer natural gas demand is down and prices have started to pull back as well; however, I doubt you'll see natural gas get back to the really low levels we saw in 2012 and early 2013.

 On the oil side, a number of factors there as well.  We are seeing the recovery and demand globally as a result of the global economic recovery.  We also saw some political instability, of course, in Iraq that effected global oil prices. 

US oil prices continue to be lower than global oil prices; however, they have also drifted higher as well, partly as a result of the sympathy with natural gas and partly as a result of what's going on globally and I think that's, kind of, what we're going to continue to see for the balance of this year. 

We're going to see global oil prices be relatively high.  We have a fairly tight supply and demand balance globally and you'll probably see US oil prices trade at about a $10 to $15 a barrel discount, generally speaking, to Brent, which is the key international oil benchmark.

Steven Halpern: So, let's turn to the two stocks that you had picked as your favorite for 2014 and-for more conservative investors-you chose Marlin Midstream (FISH) which is now up over 25%.  What was your original rationale for the pick and what accounts for its strong outperformance?

Elliott Gue:  Absolutely.  Well Marlin Midstream is a natural limited partnership or MLP.  It's a fairly new name.  It went public in 2013 and one of the things I look for with MLPs is-I actually like to look at brand new MLPs that just went public and this seems a little unusual. 

I think IPOs, or newly listed companies, have a really bad reputation with many investors because of what happened during the tech boom back in the 1990s, but with MLPs, it's really an interesting place to look. 

When an MLP first comes public, especially a name like Marlin, which is a very small-cap name-Marlin only has a market cap of less than $400 million-they tend to be under the radar and a lot of investors ignore them. 


They don't have a lot of institutional support and, therefore, it kind of languished for a bit, until they start actually paying out distributions and then that actual yield begins to attract investors, so I do tend to look at newly IPO'd MLPs very closely to see if they have any fundamental value as well, and, in the case of Marlin, one of the things I like about this name is their oil infrastructure business. 

In particular, they have rail trans loading facilities and what those are are facilities that allow producers to take oil from trucks, or from a local gathering system, and load them into train cars, and, of course, this has been a huge trend in the US over the last couple of years because of a lack of pipeline capacity stretching into many of the key shale fields.

In fields like the Niobrara shale in the Rockies or the Bakken shale in North Dakota they are actually using rail instead of pipelines to load oil and to dispense more oil to market, so that was one thing that really attracted me about them.

Very few people were paying any attention whatsoever to FISH late last year because it only really paid out one distribution when I recommended it, but now that they've shown not only that they can pay distributions, they are also growing in distribution at a rate pace as they build out this new infrastructure.  The stock obviously caught a lot more attention and I think it's performed well as a result of that.

Steven Halpern:  Now, your more speculative pick for 2014 was Patterson-UTI Energy (PTEN), which is now up over 40% since you first recommended it.  What was your thinking behind this recommendation and what has happened so far this year?

Elliott Gue:  Patterson-UTI is a land-based contract drilling company, and what that means is they don't actually produce oil and natural gas but they own these rigs, these large drilling rigs that are used for drilling in a lot of these shale fields. 

What's important over the last few years in this business is that, you know, five or ten years ago, a lot of the land rigs that were out there were mechanical rigs which are exactly what it sounds like.  These rigs used gears and just mechanical mechanisms to turn the drill bits, and again, a diesel engine, of course, to provide the power. 

Now the problem with the mechanical rig is they really weren't accurate enough, in terms of drill feed, to be used in shale fields, which require more careful control of the drill bit itself.  They also, in many cases, didn't have enough horsepower to drill these really deep shale wells that are being drilled today. 

In many parts of the US, you're drilling wells which are 5,000 to 10,000 feet deep, at least, and then you're also drilling these long horizontal segments or lateral segments that can be 5,000 and 10,000 feet long.

These really long wells, you simply couldn't drill them with these mechanical rigs, so what we've seen is the wholesale replacement of mechanical rigs with electric rigs, which allow a much more careful control of the drill bit itself and the drilling speed. We've also seen a wholesale migration to more powerful rigs that are capable of drilling the shale wells. 

The final innovation we've seen is something called pad drilling, which means that, in the old days, you know, you might have a rig and you drill one well.  Then you load that rig up on a truck and drive it a mile down the road and drill another well.


That took a long time to disassemble the rig between wells, move the rig.  Nowadays, what we're seeing in a lot of the shale places is called pad drilling.  You have a fairly small area, which is known as the drilling pad and the rig itself only has moved about ten or 15 feet in between wells. 

What that means is that the time between wells, the time wasted between wells is much lower-a rapid increase in drilling efficiency.

And what Patterson has is what's called a walking rig and these rigs actually have hydraulic feet which allow the rig itself to walk between one well and the next well, and instead of having to actually take down the rig, or disassemble the rig, and move it, you're actually able to walk it from well to well in a fully rigged up basis. 

You don't have to waste a lot of time between wells.  Big increase in efficiency.  What I really liked about Patterson and really continue to like about Patterson is that the company is replacing all of its old fleet of mechanical rigs, which are totally unmarketable at this time. 

None of the producers are interested in using them, and they are replacing all those older rigs with brand new walking rigs, which are in very high demand and earn very healthy margins, so, as their fleet goes from three or four years ago, it was about 50/50 mechanical rigs and electric rigs. 

Now it's moving more and more towards being an all-electric, an all walking rig type of fleet.  As that happens, I think you're going to continue to see their margins improve, and that's going to continue to drive that stock higher.

Steven Halpern:  So it sounds like you're still bullish on both of these names, Marlin and Patterson-UTI.  Would you continue to recommend holding these for those who followed your initial recommendation at the beginning of the year?

Elliott Gue: I would.  I think that Marlin is probably the one that I believe is getting closer to fair value now. Actually, in my newsletter, I actually have it as a hold rather than a new buy, so I really wouldn't commit new capital to that name.  As I said, it has run up a lot; however, I would start looking in that area. 

There have been a number of fairly recent MLP IPOs, which I mentioned is a very fruitful area to look at.  The other area in the space to look at would be maybe looking at some of the MLPs that are in unusual business lines.  One name I would look at is the SunCoke Energy Partners (SXCP). 

This company is not in the normal energy midstream business and therefore I think it's a little bit under the radar and that's what I'm really looking for in that space.  MLPs have performed so well, the average yields are down so far. 

You really have to look beyond just that normal midstream business-some of those names like Marlin that are new IPOs, or like SunCoke that are in unusual businesses. 

As far as Patterson, this is still a name I like a lot.  Obviously, it has run up a lot so you do occasionally see it pull back sort of 5% or 10%.  It would be a great opportunity to buy, but over the long-term, I think Patterson is going to be a name that is going to perform very well.  The story is absolutely intact from what I talked about at the end of last year.

Steven Halpern:  Well, we really appreciate you taking the time today.  Thanks for joining us.

Elliott Gue:  Thanks for having me.

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