Two Small Energy Giants

06/24/2008 12:00 am EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt, editor-in-chief of Growth Report, finds two small-cap energy companies he believes will continue to rack up big gains in the years ahead.

Soaring crude prices, which reached an all-time high in May, trading above $135, have left oil companies posting meteoric gains over the last several quarters.

T-3 Energy Services Inc. (Nasdaq: TTES), a Houston-based oil and gas drilling products and services company, has been no exception: Shares of the company have risen more than 50% in the past six months.

T-3 is engaged in the design, manufacture, repair, and servicing of products used in new oilfields and gas wells; the workover of existing sites, and the production and transportation of gas and oil. Its list of customers includes oil giants Exxon Mobil and Marathon Oil.

[Since] October 2007, the company bought three other service companies. T-3 also opened a new wellhead service facility in Grand Junction, Colo. In March 2008, T-3 inked a five-year joint venture agreement with Dubai-based Aswan International Engineering, which opens up a new market for the company's licensed products throughout the Middle East.

On May 7, T-3 announced it posted a 73% jump in fourth-quarter profit, boosted by acquisitions, geographical expansion, and rising demand. Quarterly net income came in at $9.5 million, or 75 cents a share, compared with 51 cents a share in the previous year. Revenues rose 44%.

TTES outpaces the competition in both revenue growth and margins. Analysts are expecting [fiscal 2009 earnings per share] to be $4.00, with revenues of $346 million. Our target price of $80 is based on a multiple of 20x forward earnings. (It closed at around $74 Monday—Editor.)

Innospec Inc. (Nasdaq: IOSP) is a fuel-treatment company that produces lead-based additives used by refiners to increase the octane rating of gasoline. It has three distinct business segments: fuel specialties, active chemicals, and octane additives. In 2007, fuel specialties accounted for 62.2% of net sales, active chemicals made up 22.2%, and octane additives comprised the remaining 15.6%.

Although its octane-additives business is profitable, the segment has been experiencing declining demand and will likely cease to exist in the next several years. The reason is that Innospec’s octane-additives business comprises sales of tetra ethyl lead (TEL) for use in automotive gasoline. The company has done an excellent job of growing its fuel specialties and active chemicals segments to compensate for the expected drop off.

The company has a market capitalization of $590 million and has seen its stock price appreciate more than 200% over the past five years. Total revenues for the first [fiscal] quarter were $168.7 million, a 16% increase over the [previous] year. Earnings per diluted share [for the full year] climbed to 30 cents a share from 24 cents in 2007. The company also increased its semiannual dividend 11% to five cents per share.

At current levels (below $24 Tuesday), the stock is trading below our fair value estimate of 16x forward EPS, or $30.

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