Wind power demand is expected to rise in 2013 after the wind production tax credit was extended last week, benefiting wind power companies like Broadwind Energy (BWEN), GE Wind (GE) and Berkshire Hathaway’s MidAmerican Energy (BRK.B), says Christopher Blansett Senior Equity Analyst at J.P. Morgan Chase & Co.
“We did raise our estimates for [Broadwind] because of the expectation that there would be more wind power demand in 2013 due to the PTC extension. And also, I think, specific to those companies that have remained in the wind industry like Broadwind, they have had a lot of their competition drop out,” Blansett said.
Blansett expects higher profit margins for the few wind power companies that remain in the game given the decreased pricing pressure after many companies exited the industry, and he says that even in decreased volumes for the industry the margins should improve incrementally. He also says foreign imports from countries like Vietnam and China are expected to have less of an impact in 2013.
One company that remains a player in wind energy and has increased its wind portfolio is Berkshire Hathaway’s MidAmerican Wind. The company acquired two wind energy projects in Tehachapi, California, from California Highwind Power last year, as reported by the International Business Times. The power produced will be sold to Southern California Edison in an agreement that extends to 2035.
GE Wind also remains as one of the few companies with exposure to wind. The company manufactures onshore and offshore wind turbines with capacities ranging from 1.5 MW to 4.1 MW, and it also provides support services like development assistance and maintenance.
Some of the best-performing names among oil companies are expected to come from those owning acreage in top-producing U.S. shales and basins like Bakken, Eagle Ford, Permian and Utica, says Leo Mariani, RBC Capital Markets Analyst. These names also display improvement in capital efficiency for 2013.
“One of my favorites is Continental Resources (CLR). I expect to see a number of improvements in the Bakken play during 2013. I expect to see narrower price differentials versus WTI, lower well costs, and just general expansion in inventories in the plays due to successful downspacing and also successful test of the lower benches of the Three Forks reservoir,” Mariani said.
Mariani also likes Approach Resources (AREX), which has exposure to the Permian basin. He expects materially improved capital efficiency and higher production growth out of this company in 2013, and also continued successful horizontal wells drilled in the Permian and in multiple benches of the Wolfcamp.
His final favorite is EOG Resources (EOG), a name with acreage in the Eagle Ford in Texas. “Oil liquids growth, upwards of 30%, we think should occur, and during the year [EOG] may unveil a couple of new oil plays in the U.S., which could certainly add value. We also think they have a decent chance of erasing their free cash flow deficit. They have been outspending cash flow for a number of years, and to really get back much closer to positive by the end of the year, we think should be a catalyst for the company as they continue to ramp cash flow pretty aggressively,” Mariani said.
The Raymond James team favors oil and gas companies with a bigger and more diversified asset base, given the current uncertainty on where the prices of commodities are going, says Andrew Coleman, Managing Director at Raymond James & Associates, Inc. The RJ team also looks for lower leverage and reduced execution risk.
“On the oil side, I’d look at someone like Continental Resources (CLR). Short term, they’ll grow almost 60% in 2012. Their forecast for 2013 is north of 30%. They have the balance sheet to withstand outspending by about $1 billion next year by our model. And if you want to go a little bit longer term, Denbury Resources (DNR) is attractive on the oil side given the large resource potential management is ramping up through its tertiary oil operations,” Coleman said.
Coleman also looks at the gas side, where he prefers companies located or with exposure to the most attractive basis. Although he has a “market perform” rating on these companies given their high valuation and the not-bullish call on natural gas from the RJ team, but he says it’s worth to keep an eye on whether fundamentals improve.
“Based on what I’ve seen from an IRR standpoint, the Marcellus is the best-returning gas play out there. Players like Cabot (COG) and Range (RRC) have the biggest exposure there, with perhaps Southwestern (SWN) or Ultra Petroleum (UPL) too,” Coleman said. “They are worth keeping an eye on if fundamentals keep improving.”
Natural gas consumption is expected to continue growing into the year 2020 in the United States at the expense of coal and roughly at twice the rate of oil, leaving coal companies like Alpha Natural Resources (ANR) in a difficult position going forward, says Iain Reid, Senior Equity Research Analyst at Jefferies & Company, Inc.
“From 2012 onwards, we’re forecasting a rate of growth which is 2.7% per annum compound to 2020,” Reid said. “Gas demand is expected to grow faster than coal. In fact, it is displacing coal or should be displacing coal in the longer term in most of the major markets either due to price reasons or due to environmental reasons.”
Reid says the demand for natural gas from OECD countries has been difficult in the years since 2008, but demand since 2012 is on the rise. He adds, however, that Europe has been slower in its phasing out of coal due to cost pressures.
“[Reduction of coal consumption] hasn’t been the case in 2012 in Europe, which has got an environmental ambition to try and drive coal out of the generation market, but coal is so cheap now compared to natural gas in Europe. In fact, the opposite has been occurring in this year,” Reid said.
HollyFrontier Corporation (HFC) is growing its dividend and has been offering special dividends on a regular basis, powered by its pure-play strategy of supplying the strong demand growth from the Rockies with its refined products, which are refined from some of the cheapest crudes in the market, says Paul Sankey, Analyst at Deutsche Bank Securities Inc.
“On HollyFrontier, basically what you are looking at is a Rockies refiner, and what you have in the Rockies is proximity to the cheapest crudes from growth in Canada and growth in the Bakken and other midcontinent areas as well as exposure to a lot of steady strong demand growth from strong Rockies demographic growth and industrial activity,” Sankey said.
Sankey says HFC benefits from the lack of enough domestic refineries, especially as there isn’t much imported-oil activity in its geography, allowing this refiner to take the cheap crudes available in the region and turn them regularly into more than one special dividend per quarter.
“What we want from refining, as you see it’s a low growth business, is cash returned to shareholders. We are not interested in guys who buy assets, we are not interested in guys who spend a lot of money to expand their refineries; we are interested in companies that pay out cash. And let’s say for HollyFrontier — ticker HFC — its ticker should instead be ATM,” Sankey said.
Petroleo Brasileiro Petrobras SA (PBR) continues aggressively borrowing and consistently outspending cash flow without a meaningful growth in production expected until 2014, a campaign that is particularly difficult in an environment of falling oil prices, says Pavel Molchanov, Analyst at Raymond James & Associates, Inc.
“This company has debt of $92 billion as of September 30. That’s just a stunningly large number for any corporation, even one as big as this one. That equates to a debt-to-cap ratio of 35%, by far the highest within its peer group. So to put that in perspective for you, Exxon’s (XOM) debt to cap is 7%, Chevron’s (CVX) is 9% and Petrobras’ is at 35%,” Molchanov said.
Molchanov says Petrobras is one of the least-conservative companies among the oil majors, and it is expected to continue borrowing in 2013 to fund its aggressive capital spending program and its dividend, possibly increasing the $92 billion debt to levels as high as $111 billion, worsening leverage ratios, which he says is troubling.
“Last year production was flat. In 2012 it’s actually down, and it’s going to be essentially flat again in 2013 and may resume meaningful growth only in 2014. In the meantime, the company is borrowing billions of dollars every quarter, and in the context of a downward trend in oil prices that’s not a very sustainable strategy. Although the stock is already down sharply year to date, we just don’t see much reason for it to go up over the next six to 12 months,” Molchanov said.
Exxon Mobil Corporation (XOM) is expected to outperform riskier oil and gas peers through its defensive oil-production strategy in a year where oil prices are are already correcting and are expected to decline due to supply outstripping demand, says Pavel Molchanov, Analyst at Raymond James & Associates, Inc.
“Quite simply, Exxon is a stock that tends to outperform when oil prices are choppy or declining. Conversely, if we thought oil was going to rip higher next year, this would be not be a stock that we would be overly excited about, because by definition it is very defensive and conservative,” Molchanov said.
Molchanov says XOM can fund its entire capital program and its entire dividend payout and still have cash left over to do share repurchases this year, something that sets it apart from the rest of the riskier approach of most oil and gas companies, and he says production was in fact down in 2012.
“[Exxon Mobil is] just a fundamentally well-run, conservatively managed company, and precisely because we think oil has downside next year, we have long been encouraging investors to gravitate towards defensive stocks like this one with solid dividend yields and balance sheets,” Molchanov said.
Business development companies have shown a positive performance in 2012, and the favorites are Ares Capital Corporation (ARCC), Fidus Investment Corporation (FDUS) and THL Credit (TCRD) for Vernon C. Plack, CFA, Director of Research at BB&T Capital Markets.
“We’ve had strong portfolio growth, which generated good earnings growth as well as solid dividend growth. Going forward, the companies that we favor are those that we believe will continue to show above-average dividend growth and are priced at reasonable valuations,” Plack said.
On the larger-cap side, Plack prefers Ares Capital. “We believe that the company is overearning its dividend, and we are looking for growth of 8% during the next 12 months,” he said. “The management team has done an outstanding job of investing and their acquisition of Allied Capital has been highly accretive.”
On the smaller-cap side, Plack likes Fidus Investment and THL Credit. “Given available cash and the ability to borrow from the SBA, we think Fidus will have strong portfolio growth over the next 12 months and believe that they can increase their dividend 16% during the 12 months. We believe THL is a similar story given capital availability, and we think they will be able to grow their portfolio roughly 30% over the next 12 months, which should drive dividend growth somewhere in the 12% range,” he said.
Waste Management (NYSE:WM) has turned its business around over the last decade, changing its management and becoming a leader in recycling and waste to energy in the U.S., creating a long-term opportunity for investors, says Todd C. Ahlsten, Chief Investment Officer and Portfolio Manager at Parnassus Investments.
“We think management, as I mentioned, has improved dramatically in the last decade — good corporate governance, good thinking ahead, investing in next-generation recycling waste energy,” Ahlsten said. “The stock is in the low $30s, and we see downside into the mid-$20s if there’s a recession, and upside to well over $40 a share in the next three years if they execute on their plan, so we like the range of outcomes. The stock also has a dividend yield about 4%.”
Ahlsten also says Waste Management has made significant investments in waste to energy and capturing methane from landfill sites. He visited a landfill site in Altamont Pass in California, and he says they are producing liquefied natural gas and CNG there. He also highlights the company’s advances in worker safety, which translates into fewer accidents, less downtime and improved relationships with workers.
“When we look at this investment, it is increasingly relevant because we view waste disposal, recycling and waste energy as important long-term businesses. They have a wide business moat as landfills are hard to zone, and we think they have some great properties,” Ahlsten said. “On the ESG story, we like their investments in recycling and in waste to energy, and we think they’ve done some really good groundbreaking things in those sectors. So Waste Management really reflects our process; it’s a long-term investment.”
The Procter & Gamble Company (NYSE:PG) is increasing the profitability of its over $1 billion a year in sales in globally well-known brands like Pampers, Crest and Gillette through waste-reduction practices, while at the same time combining organic growth with share buybacks, creating a long-term investment opportunity, says Todd C. Ahlsten, Chief Investment Officer and Portfolio Manager at Parnassus Investments.
“From a valuation standpoint, we think P&G has just bedrock cash flows, dividends, and versus its current price of $68 per share, we see downside into the mid $50s and upside into the $80s in the next three years. Combined with the dividend yield, we like the risk/return,” Ahlsten said.
Ahlsten also highlights P&G‘s waste reduction in brands like Gillette, where they have cut plastic by 50% and weight by 20% in some models, a practice that made sense environmentally as well as financially. P&G is also engaged in ESG-type practices through its PUR water products, and the company has provided over a billion liters of clean water in developing areas for children.
“From an ESG standpoint, P&G has done a lot of very good things, such as reducing waste and energy usage by over 50% in the last 10 years, reducing CO2 emissions over 50% in the past decade, and finally, cut water usage by over half as well. So in terms of waste, water, energy and emissions, kind of WWEE, they’ve all reduced those by 50% to 60% in the past 10 years, which is a tremendous focus on those areas, which not only makes business sense, but obviously is great for the environment,” Ahlsten said.
