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3 energy companies the insiders are buying
There is still time for smart stock picks in the energy sector. Learn why executives at Chesapeake Energy, Goodrich Petroleum and Input/Output are snapping up shares.
By Michael Brush
With crude oil prices setting records almost daily, and with most energy stocks double where they were two years ago, its easy to think the energy-investing opportunity has passed.
Easy to think, but wrong.
Look at the insiders. At companies such as Chesapeake Energy (CHK, news, msgs), Goodrich Petroleum (GDP, news, msgs) and Input/Output (IO, news, msgs) executives are still buying their own shares in a big way, a good signal that more gains are to come.
Better yet, check out the ongoing supply-demand imbalance. On the supply side, theres not much spare global production and refining capacity, says Steve Enger, an oil analyst at Petrie Parkman & Co., a Denver, Colo.-based brokerage that follows energy stocks. Meanwhile, you have off-the-charts demand, which keeps the system under pressure.
Enger doesnt see much relief on the horizon. So he predicts oil -- which recently topped $70 per barrel -- will trade in the $40-to-$60 range much of the time over the next several years. He thinks North American natural gas, trading recently near $10 per thousand cubic feet (MCF), will trade in the $5 to $9 range.
With those forecasts in mind, here's a look at those three companies where the insiders are showing you the way.
A bet made early pays big
In the late 1990s, Chesapeake Energy was one of the first energy companies to foresee the looming supply-demand imbalances of natural gas.
So it got a jump on competitors in snapping up cheap reserves -- primarily in Oklahoma and Texas. We got to the right answer sooner than others and stuck with it, says Chesapeake chairman and chief executive Aubrey McClendon.
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The company has spent more than $7.1 billion buying reserves in the past seven years. Today Chesapeake is the third-largest independent producer of U.S. natural gas. The company has nine years worth of inventory to drill. In contrast, competitors on average have about two or three years of ideas to drill, says Jeffrey Mobley, who handles investor relations for the company.
Since 1998, the company has paid between 83 cents and $2.25 per MCF on average each year to buy reserves. So far this year, natural gas has sold for $7.49 per MCF, on average.
Even though the price of natural gas is up a lot, Chesapeake thinks it can continue to make smart acquisitions. One reason is that it will keep focusing on the smaller operators its bigger competitors overlook. Chesapeake also has a leg up on competitors because it has a hand in so many drilling projects in and around Oklahoma. This gives the company an inside look at whats working and whats not.
The company estimates that, through acquisitions and development, it can increase reserves by more than 13% by the end of 2006. It expects production to grow 12% in 2006, following a 27% increase in 2005.
Another plus for Chesapeake: The company suffered huge losses in the 1990s. That means it won't have to lay out cash for taxes until after 2008.
Despite all these advantages, Chesapeake is a lot cheaper than peers like XTO Energy (XTO, news, msgs), EOG Resources (EOG, news, msgs) and Newfield Exploration (NFX, news, msgs). One reason is that investors worry about Chesapeakes relatively high debt levels. But with natural gas trading near $10 and oil at $68, Chesapeake should have little trouble paying off its debt.
That could explain why insiders -- primarily Chesapeake co-founders McLendon and Tom Ward, who serves as chief operating officer -- have purchased an impressive $80 million worth of their companys stock since the start of 2004 at prices ranging from $13.13 to $28.35, according to Thomson Financial. Those buys include recent purchases worth $12.4 million in the second half of August for prices between $26.55 and $28.35. The two co-founders now own about 12% of the companys stock. (View recent purchases here.)
Untapped reserves, on sale
Like Chesapeake, Goodrich Petroleum took positions in natural-gas fields before energy prices went bonkers, and it is enjoying the benefits. Goodrich has a big position in the Cotton Valley Trend in east Texas, a low-risk field that has long-life reserves. It also has fields in southern Louisiana.
Goodrich is just in the early stages of exploiting its Cotton Valley Trend holdings. The companys 50,000 acres there can probably support over 1,000 wells. To date, Goodrich has drilled just 34 wells.
Directors and top execs have a huge position in this company -- controlling about 54% of the stock. This tells me that investors made a mistake when they sold the stock down hard in August because production increases in the Cotton Valley Trend came in below expectations.
Insiders have purchased $14.4 million of Goodrich's shares since the middle of May for prices as high as $19.07. So the 13% decline in the stock in August, to around $20, offers a good entry point for long-term buyers. (View recent purchases here.)
The oil hunt's newest tool
When oil prices shoot up dramatically, the major oil companies are typically slow to rev up their search for new reserves. For one thing, they dont believe oil prices will stay high. They also find it easier to circle back to old fields they know well and go after oil that wasnt worth bringing out before.
Its the same in the industry this time around. But as oil prices stay high, the oil companies will step up their exploration efforts. That should help kick-start sales of a new and advanced seismic exploration technology developed by Input/Output.
Since the early 1990s, oil companies have used an older 3-D seismic technology to capture images of energy deposits underground. It shoots sound signals into the earth and then uses the reflections to map rock formations and underground pockets of crude and natural gas.
About two years ago, Input/Output came out with a system known as digital full-wave seismic, a system the company calls VectorSeis. Instead of just capturing the main sound waves that come back, full-wave digital picks up the echoes of the initial signal as they bounce around in underground formations.
This helps create much better images of rock structures, fractures and the fluids in underground reservoirs. Think of it as bringing high-definition TV to the oil exploration business.
Although full-wave digital has been available for two years, oil companies have been slow on the uptake. That doesnt surprise Michael Kirksey, the finance chief at Input/Output. It took oil companies anywhere from five to eight years to get on board with the current version of 3-D seismic when it came out in the early 1990s, Kirksey says. With this version, he says, we are in about the second or third inning.
You can already see signs that interest is picking up. Spending on full-wave seismic was $30 million in the first half of 2005, compared to $37 million for all of 2004 and $7 million in 2003, says Johnson Rice & Co. analyst, Joe Agular.
Insiders seem confident those gains will only continue. Since last November, they purchased $2.5 million worth of stock in the $6 to $8 range, according to Thomson Financial, or near recent levels of $7.60. (View recent purchases here.)
Agular reckons the stock could trade up to $10 in coming quarters if sales growth and industry interest stays on track into 2006.
Count on volatility
While all of these stocks are good buy-and-hold candidates, theyll make good trading vehicles, too. Energy analysts expect energy prices to be volatile. As Hurricane Katrina showed, when supplies are tight, unexpected events cause prices to spike. So could a terror strike. Energy stocks will bounce around a lot along with the prices of oil and gas.
One thing you can count on is volatility, says Chesapeake CEO McClendon. We will have periodic train wrecks when supply cant keep up with demand, or Mother Nature throws us a curveball.
However, while both Chesapeake and Input/Output report no problems from the hurricane, Goodrich suspended production in two fields in Louisiana. The company was doing a flyover Tuesday to help figure out when it might reopen the operations. If it cant reopen them soon, the shut down could have an impact on near-term results, but it doesnt change the long-term prospects for the company, said Goodrich chief executive Walter Goodrich.
Stock picks
With this column, I'll add Input/Output and Goodrich Petroleum to my Company Focus portfolio for tracking, and we'll see how they do from here.
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