Energy Sector Stock Evaluations

1
Energy Sector Stock Evaluations

• Brian R. Boulter
• Fisher College of Business
• 2/27/07

2
Comparative SIM Sector Allocation
3
96
57
34
4
Sector Recommendation

• Oil Prices are likely to remain relatively flat
  between 45 and 60 per barrel.
• Energy sector performance is still adjusting to
  the decline and energy companies in general are
  likely see flatter earnings in the future.
• Recommend to decrease current SIM portfolio
  weighting to 7.00
• Sell 73 basis points to reach 269 basis points
  below SP 500 weighting
• Look to move towards equal weighting after 12-14
  months

5
Industry Fundamentals

• Integrated Oil Gas - 63.76
• Oil Gas Refining Marketing 3.30
• Oil Gas Exploration Production 9.61
• Revenues and earnings in these industries are
  very tightly correlated to oil prices
• Crude oil is either a major input for production
  of goods for sale or is itself the sole output of
  production.
• Short-term oil price volatility results in more
  earnings volatility in these industries.
• Stagnant oil prices are likely to limit growth
  and performance in the near future.

6
Industry Fundamentals

• Oil Gas Drilling 4.21
• Oil Gas Equipment Services 13.39
• Oil Gas Storage Transportation 4.34
• Revenues and earnings in these industries are
  driven by global supply and demand factors more
  than actual oil prices (not as highly correlated
  to oil prices)
• As long as oil is a primary source of energy,
  drilling, storage and transportation services
  will be in high demand.
• Revenues and earnings tend to be more stable than
  short-term oil prices
• May be an opportunity for stable growth when
  demand is growing yet oil prices remain stagnant

7
Industry Fundamentals

• Coal Consumable Fuels - 1.38
• Recently, high oil prices have spurred the
  development of new coal conversion technologies.
• Coal can now be economically converted into
  natural gas, liquids and hydrogen.
• Quickly becoming a significant source of
  unconventional oil production as oil prices
  steadily rise with increased demand over time.
• Current conversion methods result in costs of
  about 35 per barrel of liquid hydrocarbons

8
Recommendation

• Buy 125 basis points of SLB
• Buy 167 basis points of BTU
• Sell 365 basis points (ALL) of VLO
• Total SIM weight 7.00
• Total SP 500 weight 9.69

9
Schlumberger Ltd. (SLB)

• Oil Gas Equipment Services Industry
• Leading oilfield services company
• By market cap. and earnings (second to HAL in
  revenue)
• The Oilfield Services segment provides
  technology, project management and information
  solutions to the petroleum industry.
• The WesternGeco segment provides reservoir
  imaging, monitoring and development services.
• Established 1926 and currently operates in 80
  countries worldwide

10
(No Transcript)
11
SLB Comparative Financial Strength
12
SLB Comparative Profitability
13
(No Transcript)
14
(No Transcript)
15
SLB DCF Assumptions

• CAPM produced 9.4 terminal discount rate (Beta
  1.35)
• Terminal Growth Rate of 5.75
• Increasing demand for oil and oil
  drilling/production services
• Current high operating margins declining to
  industry average of 18
• Cap Ex. and Depreciation approaching 5 of sales

16
SLB DCF Output
17
SLB Multiple Valuations
18
Peabody Energy (BTU)

• The worlds largest coal producer founded in
  1883. (IPO May, 2001)
• owns interests in 36 coal operations in the
  United States and Australia.
• Produces about 240 million tons of coal annually
• Has approximately 9.8 billion tons of proven and
  probable coal reserves
• Markets, brokerages and trades coal
• US customers, primarily power companies,
  currently account for more than 90 of sales
• Participates in BTU conversion technologies that
  convert coal into natural gas, liquids and
  hydrogen.

19
(No Transcript)
20
BTU Comparative Financial Strength
21
BTU Comparative Profitability
22
(No Transcript)
23
(No Transcript)
24
BTU DCF Assumptions

• CAPM produced 12 terminal discount rate (Beta
  2.01)
• Terminal Growth Rate of 5.00
• Current moderate operating margins increasing
  slightly to industry average of 14
• Cap Ex. and Depreciation approaching 5.5 of sales

25
BTU DCF Output
26
Valero Energy (VLO)

• Oil Gas Refining Marketing
• Founded 1955
• Operates 18 refineries in the United States,
  Canada and Aruba
• Markets transportation fuels and home heating
  oils to residential consumers
• Operates 1,008 company owned gas stations and
  5,000 retail and wholesale outlets

27
(No Transcript)
28
VLO Comparative Financial Strength
29
VLO Comparative Profitability
30
(No Transcript)
31
(No Transcript)
32
Comparative Dupont Analysis
33
Recommendation

• Buy 125 basis points of SLB
• Increasing demand for oil and oil will result in
  stable growth despite stagnant oil prices.
• Buy 167 basis points of BTU
• Coal becoming a viable unconventional source of
  oil and gas
• Sell 365 basis points (ALL) of VLO
• Stagnant oil prices will limit short-term growth
  in this industry

34
Final Energy Sector Portfolio
Final Sector Weight 7.00 SP 500 Weight
9.69 Underweight (2.69)