We keep getting asked a single question from readers and from our own industry and professional contacts: Are Oil Stocks Cheap? There is a very simple answer in today’s markets: Oil stocks look very cheap (if oil is going to stay anywhere near $70.00).  Some of these are our top picks and some are incidental, but the reviewed stocks are ConocoPhillips (NYSE: COP), Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), Murphy Oil Corporation (NYSE: MUR), Petroleo Brasileiro (NYSE: PBR), PetroChina Co. Ltd. (NYSE: PTR) and Valero Energy Corp. (NYSE: VLO).  By our measure, some of these major integrated oil and exploration and production stocks are undervalued by 10% to 25%.  Some may be even more undervalued than that in the large-cap and super-cap arenas.

Answering any question of whether a stock or any instrument is cheap does actually require a crystal ball that sees the future for it to be certain beyond a snapshot in time, but if oil stays around these levels then many of the major oil stocks still seem to have more room to run up.  Dare we call this value investing?  This is not a review of every single sector in the oil patch, as we are reviewing these stocks  in groups.

ConocoPhillips (NYSE: COP) is still a dirt cheap stock that fits into the “and more upside” when talking about if it is 10% to 25% undervalued.  That is even if Warren Buffett is losing his “assets” on this pick. The company was an equity investor’s train wreck when we picked it to be one of our energy stocks to double by the end of the recession, but that pick was based on an oil recovery.  Nothing has changed in our view, and now that the price of oil is way above its threshold of somewhere around $52.00 oil as the break-even point in our mind the company should be well on its way back to profits.  Analysts have already ratcheted their estimates higher for 2009 and 2010, but they are still far under where this was when Conoco went public.  While most major oil names are down over the last two-year period, Conoco is down the most at almost 40%.  Conoco isn’t out of the woods for 2009, but if it can get anywhere close to normalized earnings close to $6.00 for 2010, then Thursday’s $45 handle could easily look like a $60.00 handle… and its 52-week trading range is $34.12 to $95.96.

Exxon Mobil Corp. (NYSE: XOM) is in a situation where its market cap may be its single largest obstacle.  When investors can invest in ETF’s and not have to chase a $360 billion market cap, it is a pretty easy call.  It was two-years ago when oil was $70.00 and it had not gone parabolic yet.  But as it doubled to $140 and higher through summer of 2008, Exxon shares traded in a dead-stop trading band of $82.00 to $95.00.   We think Exxon will always keep a size-discount on its multiple, but Exxon could easily trade to $80.00 or $81.00 again.  The company never believed in the higher oil prices and did not invest accordingly. But it also kept an even keel.  This new huge project in Alaska could be the first of many.  Despite the rise in oil prices over the last 90-day period, there has yet to be any significant recovery in forward earnings projections.  As those numbers get back to even a mid-point to an estimated $4.30 EPS target for 2009 and a $6.26 target for 2010,  this one has room to run back toward $80.00.  Could we have just easily analyzed rival and fellow DJIA component Chevron Corp. (NYSE: CVX)?  Sure.  We can see Chevron hitting $80.00 as well, and its $144 billion market cap might actually allow Chevron to do that faster.

Murphy Oil Corporation (NYSE: MUR) may be our old wildcatter story stock, but higher oil prices cannot and will not be the only factor here with its production and marketing operations offsetting the exploration.  Murphy has a history of having good hits and bad misses, which in turn has created large upside and large downside moves in investor sentiment.  That actually seems to have smoothed through time.  History is just hard to ignore for us.  At $60.00 we feel it is close to a fair value, although at $66.00 it does not get ridiculously above a 12-multiple on forward 2010 earnings from one-third of the analyst pool that covers it.  With shares up 50% from the 2008 lows, this one is more in-line with the 10% upside crowd.  It would probably take one of those big surprises for us to get too much more positive than this.

Petroleo Brasileiro (NYSE: PBR), or PetroBras, is a wild card of the lot for the BRIC country oil majors.  We like the company and like its position in Brazil and emerging markets, but this  stock has already doubled from the late-2008 lows and its market cap is flirting with $200 billion again.  Recent signed pacts with the Chinese and others will continue to add powder to its arsenal, but for us to endorse much more than a $50 target on a most basic analysis considering a static snapshot then oil has to get north of $80.00.  Our internal target for upside here on a static snapshot is more in the 10% range.  Even then, it feels like a biased call because of how traders loved trading this one before and because it has the BRIC attachment to it.  PetroBras has a lower market cap than PetroChina Co. Ltd. (NYSE: PTR), is more liquid, and you don’t have to spend as much time digging under the surface to see how much is owned by which branch of communist governments.

Valero Energy Corp. (NYSE: VLO) is now referred to as Vermin Energy Corp. internally because the company’s recent attempt to mimic rats.  When it double-hosed holders by saying it was losing money and raising cash to pay for what many felt was expensive acquisitions, let’s just say we lost total faith in management.  But stocks are about looking forward and it now seems to have the single largest wild card in the deck of the major refinery stocks.  If oil does stabilize around $70, then this one will do well two quarters out.  It has proven it can’t cope with dramatic rises nor with dramatic crashes.  But if prices stabilize then Vermin Energy Corp. could actually get its formal name back.  Furthermore, it could fall into the “and them some” on the upside target.  The stock already went from $15 to $25 during a bad stock market and even the recent news did not destroy its share price as much as management destroyed its credibility with us.  This is a scary call to make and is definitely much farther out than just a quarter or two, but we could easily justify a $25.00 price target all over again.  At $3.00 normalized 2010 earnings in a climate with oil price stability a 7-times earnings multiple gets this only to $21.00.  If the company’s recent acquisitions are better than anyone knows about, then imagine if they can get back to positive earnings surprises.  Over the last year its range was about $14 to $45, and two years ago it was more than a $70 stock.

Again, our outlook here for these stocks is based some sort of stabilization in oil prices.  If oil gets back to any of the old super-spike levels or if we see any of the sudden “panic out” trades happen in black gold, then consider this merely an academic discussion based upon a snapshot in time.  But as of today and as of $70-ish oil becoming the new norm, these major integrated oil companies and E&P and refiners mentioned here appear to be undervalued.

This group was based on companies we feel are the first line of players in the integrated oil companies and exploration or production, as well as related sectors. If you ask why we did not include the oil services names or major equipment names, there is a simple explanation.  And as for those trusts, LP’s, and LLC’s?  Stay tuned for those groups over the next week.

Jon C. Ogg
June 12, 2009

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