RealMoney Silver - The Energy Companies Exxon Should Buy

The Energy Companies Exxon Should Buy
By Vincent Farrell Jr.
2/11/2008 4:02 PM EST

The contents of this column originally appeared in two separate posts on RealMoney's Columnist Conversation Monday, Feb. 11.

Thanks to my pal, Doug Kass, for his warm welcome to me this morning. This is my first day as a commentator on RealMoney.com, and it was a nice way to start. I do read Honorary Uncle Doug's stuff to my now 17-month-old granddaughter, Lola Jane. I also read "Where the Wild Things Are," "Goodnight Moon," and "Knuffle Bunny" although both Doug and I are challenged by the latter. I'm looking forward to trying to chart the waters with you.

I caught the following quote from a Bear Stearns research piece this morning, "I think the subprime thing is yesterday's news ... I think we are now double-counting subprime losses," said Jamie Dimon, the correctly respected CEO of JPMorgan Chase.

I think he's right about subprime, but there is a lot of other stuff going on. I was on CNBC's "Squawk Box" this morning, and a guy from Pimco offered the thought that housing prices had another -15% on the downside. If so, then we'll have some prime losses to contend with.

I talked this morning about the dramatic slowdown in the expansion of consumer revolving debt, and it's worth noting that credit-card default rates are up a lot. Credit is deteriorating, but not on the corporate side. Balance sheets are in excellent shape, with only 11.7% of cash flow going to debt service, the lowest in decades, says the Wall Street Journal. But as long as banks want/need to shore up their balance sheets, credit will be tighter than usual, and the economy will feel it.

When would all this be priced into the market? Jason Trennert of Strategas gives it a shot in his research release today. Over the last 40 years (and yes, I remember them all), the "average" recessionary decline in earnings has been -17%. That would give us a new EPS level of around $74 for the S&P 500.

You have to make a stab at a fair price/earnings ratio to put on this, and I would agree with Jason that 17 times would be appropriate, so a downside target of 1260 results. We are at 1335 as I write this, and the January intraday low was 1221, so maybe we have already accommodated a recession into the market. Also, when the market can take a blow-up like AIG this morning and keep the fallout to that stock only, there is room for optimism.

Another friend, Fred Dickson of A.G. Edwards, notes that the yield on the S&P 500 is 2%, and the yield on the two-year treasury is 2.85% for a ratio of 70%. Only twice since 1978 has the ratio breached 70%, and both times the market was 25% higher two years later. I am not a trader (I have tried only to have most trades turn into long-term work-out situations), so a 25% gain over two years looks fine to me.

Exxon (XOM) is planning on drilling 5000 wells in the Piceance Basin (Pee-ance) in Colorado over the next few years in the search for natural gas. I think they should look to the floor of the NYSE and spend their money buying some premier natural gas names. The one I/we own at Scotsman Capital is EOG Resources (EOG) . It has the best name change ever, to its credit, having been Enron Oil and Gas.

The results have been excellent -- as have the results for Devon (DVN) and Apache (APA) , as well -- especially the reserve replacement figure of some 250% of production for last year. The majors have replaced less than 100% of production for some time now. The market cap is less than $25 billion, which is a good bit less than XOM spends each year on share repurchases. I have no inkling of anything at all, but if I were an investment banker (and thank God I'm not, the lifestyle is too intense), I would be fishing in this group. Beware, EOG is at a 52-week high.

Joe Kernan is a man among men. He's just back from having made the cut at the Pebble Beach Pro Am, and, on air, leaned on a guy to give me an invite to next year's event. Forget that I more "commit" golf than play it, and forget the guy said maybe I could caddy next year, the attempt was noble, and I won't forget it.

On this day in history in 1752, the first hospital in the U.S. was opened in Pennsylvania, and, in 1858, Bernadette of Lourdes claimed she saw the Blessed Virgin. It is also the day in 2006 that V.P. Cheney shot his "pal" Harry Wittington while hunting. Not good omens to start the week with.

I know people are taking shots, and we all might need hospitalization soon, but I'm hoping we don't require heavenly visitations to get through the day.

We will for sure continue the debate as to whether we are/are not in a recession. I think recession is probable, which, I guess, is a touch more serious than possible. The four-week moving average of unemployment claims being well below 400,000 tells us that moderate growth is likely. The recent data on revolving credit hints otherwise.

Revolving debt grew 11% in October and 13.7% in November, but plunged to a rate of +2.7% in December. I want consumers to get real but movements like this in the past have indicated that the consumer will try and maintain a lifestyle into a period of economic weakness, thus the growth in credit card debt, and then quickly retreat when the facts are clear. Banks are acting like stressed-out teenagers in this environment by cutting credit limits and upping interest rates. The Wall Street Journal reported a woman in Arizona had her interest rate reset to 30%. Aren't there laws about things like this?

Toyota isn't helping the overleveraged consumer by offering 84 month car loans. 84 months!! That's like a mortgage and we've created enough problems with those.

In the midst of this I think GE (GE) at $33.84 Friday close is attractive (I own it, so beware). The stock trades at about a market multiple, is growing well above the average and yields 3.7%. The company also has a massive share repurchase plan underway. Another is Cisco (CSCO) , which was so volatile last week. $23.54 is close to the 52 week low at $21.77 and they disappointed the Street by predicting "only" 10% growth. They will probably recover in time to the targeted 12-17% growth that CEO John Chambers thinks is the sustainable growth rate. At about 15 times the consensus estimates of $1.55 for July 2008 with $22 billion in cash (a bit shy of $3 per share), I'm happy to be an owner.

Remember, we are hoping the intraday lows of around 11,600 on the Dow (12,182 close) and 1270 on the S&P (1331 close) are the levels I hope will prove to be the bottom.

Did he really say that? Ari Fleischer, then the White House spokesman, on the fact WMD weren't found, "I think the burden is on those people who think he didn't have weapons of mass destruction to tell the world where they are." Wha....?

At the time of publication, Farrell and/or his fund was long EOG, GE and CSCO.