Editor's Note: Jon D. Markman writes a weekly column for CNBC on MSN Money that is republished here on TheStreet.com.
Crude-oil prices have plunged in the past four months by 25%, a move that has punished energy speculators, delighted SUV owners and pushed alternative-power ideas to the back burner.
If you think the price plunge is too good to be true, you're on to something. Analysts who have been around the block a few times say we almost certainly have not heard the last from the folks who brought us $4-a-gallon prices at the pump -- and suggest you make plans now to deal with another round of energy shocks over the next year.
It's not my job to recommend that you trade in your Hummer for a pair of walking shoes while the used-car market is hot. But I can strenuously recommend that you consider buying shares of some of the energy stocks now while they are on sale.
You might not like the idea of investing in opportunistic profiteers such as
, which earned a mind-blowing $10.5 billion in the third quarter on $99.6 billion in sales. But there are many other energy stocks that are less offensive and look like compelling bargains right now. With any luck, they'll help you counterbalance nasty fuel-price increases in 2007 with nice investment-portfolio gains.
Before going on to my picks, though, I need you to lift your head up out of the present and gaze to the horizon. Don't look at the month-to-month changes in crude-oil prices -- which are governed by all kinds of crazy short-term factors, including U.S. electoral politics, Nigerian hostage crises and the weather -- and instead focus on a set of indisputable facts:
- Worldwide demand for crude oil in 2000 averaged around 75 million barrels a day, according to the International Energy Agency.
- Today, demand is about 85 million barrels a day.
- By 2012, the International Energy Agency estimates, rising economic growth in markets such as China and India will spur demand to around 95 million barrels a day.
- Worldwide reserves are declining by about 15% per year.
Those additional 10 million-plus barrels a day needed by the world in six years will have to come from someplace new. The leap from 75 million to 85 million was actually not that tough, as higher prices shook loose excess capacity from Saudi Arabia, Russia and Africa. But the next gap in production is expected to be a lot harder to fill, as explorers will have to drill deeper into the oceans, slash deeper into equatorial jungles and blast deeper into Arctic tundra to find it. Forces of nature gave us lots of rich fossil fuels to burn, but in a sort of big cosmic joke, they put most of them in very inhospitable places.
If you're a gambler, the best way to bet on greater world energy production is with small oil- and gas-exploration companies. But most of you won't want to go that speculative route, as their share prices tend to shoot up and down with volatile oil prices.
Instead, you need to take this opportunity to buy shares of the companies that provide the rental equipment, chemicals and engineering know-how that make life easier for the explorers, because these companies get paid whether wells work out or not. Such companies are known as oil-field-services providers, and they are really cheap right now.
I'm going to recommend two big, steady companies whose stocks have a good shot at rising 50% over the next 18 months, and two well-managed but little-known small companies that have a shot at doubling or tripling over the next 18 months.
Let's go with the potential tripler first, since that's where the greed lobe of your brain perked up. First is
( ALY), an acquisitive Houston outfit that offers a range of drilling, production and rental services in the Gulf of Mexico and Latin America, focusing on services its larger competitors have abandoned.
Allis-Chalmers helps with tasks such as horizontal drilling in Texas, changing out drilling pipe off Louisiana's coast and providing the coiled tubing needed to snake down a gushing well to inject anti-corrosion chemicals. Demand for these services is growing faster than new drill-rig construction as oil companies attempt to maximize output from their reserves.
Allis-Chalmers has been successfully acquiring private businesses to fill these niches and helping them work together as a unit. Its savvy, frugal executive team has acquired 14 companies in the past five years, including two in the past month, with complementary services that are expected to boost earnings per share immediately and not just add revenue.
These acquisitions have provided Allis-Chalmers with tremendous cross-selling opportunities -- such as selling compressed-air drilling services to a company to which it is renting pipes -- boosting its return on capital toward the impressive 20% mark.
Just a couple of analysts cover the company, and earnings have regularly blown away expectations. For all of 2006, analysts are expecting earnings of $1.72 a share, a 236% jump over last year. For 2007, analysts are projecting just a 19% growth burst to $2.04. But I think that after the two recent acquisitions, the number will be more like $2.20. If that comes to pass, then the forward price/earnings multiple is just seven, which is crazy cheap.
David Anderson, whose hedge fund Palo Alto Investors has owned shares in Allis-Chalmers since 2004, said he thinks the company will come to deserve to trade for 15 to 20 times its trailing 12 months of earnings, which would put the stock at $30 to $40 in a year and as much as $60 to $70 in three years.
If you forget all the other stats, think about this one: It costs about $40 billion in drilling and services to develop a million-barrel-per-day oil field. The world needs at least 10 of those. Case closed.
Next, more quickly, is
, which provides proprietary chemicals and tools to oil drillers and miners. Smaller even than Allis-Chalmers, with a market capitalization of $175 million, Flotek last week reported a fantastic third quarter, with earnings up 100% over last year due to higher sales and improved margins -- a double whammy.
The stock is selling at a paltry trailing price/earnings multiple of 10 despite growth in the 50% to 100% range. Now trading at $20, it should go to $40 over the next 18 months. Anderson's Palo Alto fund is the leading institutional holder of Flotek, as he thinks the company has exercised financial discipline, reaching 20% return on capital.
As for the two big-caps, well, it doesn't take a lot of imagination to recognize that industry stalwarts
are growth companies in what has come to be perceived as a cyclical industry.
Despite terrific third-quarter earnings reports from both last week, they're trading 20% off their May highs. Both fetch forward-looking price/earnings multiples of around 15, despite earnings growth that is likely to stay in the 18% to 22% range for at least two to three years. Shares are truly undervalued at this level and will catch a spark from any spike in oil -- so start buying them now and grit your teeth in the face of any near-term volatility, because you'll have two big winners on your hands in a couple of years.
If you think oil is going back to the $40s per barrel, then you can forget these ideas. But if you think, as I do, that the Organization of Petroleum Exporting Countries will defend the $55 level and that world demand for energy will remain steady or grow over the next decade, keeping pump prices high, then investments in oil-field-services companies are the way to get your revenge.
At the time of publication, Jon Markman owned shares of Exxon Mobil, although positions may change at any time.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Allis-Chalmers and Flotek to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
Jon D. Markman is editor of the independent investment newsletter The Daily Advantage. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback;
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