JPMorgan Gets Contrarian on Energy Stocks

BOSTON ( TheStreet) -- With global growth accelerating and oil predicted to pass $100 a barrel, many analysts and investors are overweighting energy stocks.

Energy-services stocks, including Halliburton ( HAL) and Schlumberger ( SLB), have been top performers recently. The two have rallied 39% and 17%, respectively, in just three months. But one Wall Street firm is growing skeptical of the energy trade. JPMorgan ( JPM) urges caution, seeing the potential for downside this year.

The researcher resumed coverage of integrated-oil Dow components Exxon Mobil ( XOM) and Chevron ( CVX) last week, rating both stocks "neutral." Although positive on each firm's relative positioning, scope and development efforts, recent outperformance and valuation-concern substantiate the bank's lackluster outlook for the two stocks.

But, the fundamentals remain attractive. Exxon Mobil's fourth-quarter adjusted earnings increased 46% to $1.85, exceeding analysts' consensus estimate by 13%. Chevron boosted adjusted quarterly earnings 44% to $2.51, beating consensus by 4.5%. The mega-cap stocks have advanced 20% and 14%, respectively, in the past three months.

Exxon Mobil is positioned for growth, according to JPMorgan, but its North American natural gas exposure may hurt its stock performance in 2011. Natural gas, an increasingly important fossil fuel, is domestically abundant, a positive for reducing foreign-oil dependence, but a negative for the commodity's pricing as reserves continue to escalate.

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JPMorgan is forecasting a 2011 West Texas intermediate crude oil price of $89 a barrel and a Henry Hub natural gas price of $4.35 per thousand cubic feet, modest increases from current spots. A cap in commodity upside underpins JPMorgan's thesis that integrated-oil stocks may be due for a correction in 2011. Yet, the bank is bullish on exploration and production.

Here is a snapshot of ratings and targets for specific equities, by sub-industry.

U.S. Integrated Oils:

ConocoPhillips ( COP), Neutral, $68 (5% Downside)
Chevron ( CVX), Neutral, $93 (4% Downside)
Exxon Mobil ( XOM), Neutral, $78 (6% Downside)
Hess ( HES), Overweight, $75 (9% Downside)
Marathon Oil ( MRO), Neutral, $45 (1% Downside)
Murphy Oil ( MUR), Underweight, $62 (8% Downside)
Occidental Petroleum ( OXY), Neutral, $90 (8% Downside)

Exploration & Production:

Anadarko Petroleum ( APC), Overweight, $71 (8% Downside)
Chesapeake Energy ( CHK), Overweight, $32.50 (8% Upside)
Devon Energy ( DVN), Overweight, $94 (7% Upside)
El Paso ( EP), Overweight, $16.50 (At Fair-Value)
EOG Resources ( EOG), Overweight, $108.50 (2% Upside)
Noble Energy ( NBL), Overweight, $106 (19% Upside)
Southwestern Energy ( SWN), Overweight, $51.50 (31% Upside)
Williams ( WMB), Overweight, $29.50 (7% Upside)

As demonstrated, Hess ( HES) is JPMorgan's favorite integrated-oil stock, but a 6% rally in the past month has pushed its share price past perceived fair value. In the exploration and production arena, JPMorgan recommends overweighting its entire coverage, but just two stocks offer attractive upside, Noble Energy ( NBL) and Southwestern Energy ( SWN). Southwestern offers the most return potential, at 31%. It's down 12% in 12 months.

Houston-based Southwestern has outstanding growth metrics. In the past three years, it has grown sales, net income and earnings per share 34%, 50% and 48% annually, on average. Its stock delivered annualized gains of 12% over that span, despite 2010's sizable share-price decline.

Southwestern is natural gas focused, and JPMorgan is pessimistic about the commodity's 2011 pricing, seeming to contradict its "overweight" ranking. But, Southwestern's dominant position at the Fayatteville shale and balance sheet, with $369 million of cash and $1.3 billion of debt, compensate for exposure. Southwestern's profit margins are ample, with a 62% gross and a 40% operating spread.

The stock trades at a premium to its peer group, commanding a trailing earnings multiple of 22, a forward earnings multiple of 25, a book value multiple of 4.8 and a sales multiple of 5.3, 15%, 35%, 5% and 73% industry premiums. But, its cash flow multiple of 8.6 reflects a 10% discount. Other analysts offer a middling view, with 15 ranking Southwestern "buy," 16 rating it "hold" and one ranking it "sell." The company will report fourth-quarter results Feb. 25.

-- Written by Jake Lynch in Boston.


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