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Finding Value In The Carnage

Posted: Aug 23, 2007 15:04 PM by Matthew McCall

Tickers in this Article: TK, REP, FRO

The recent market selloff hurt even the strongest companies. In times of manic drops, it is imperative to find the value plays for the long-term. After sifting through fundamental and technical scans, there were two energy-related stocks that caught my eye. Both were trading at "value" levels and merit further consideration by long-term investors.

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Yield to this Shipper
Frontline Ltd. (NYSE:FRO) is one of the world's largest shipping companies. It is primarily engaged in transporting commodities around the globe. The majority of the commodities being shipped include crude products, coal and iron ore. Based on the commodities ties to producing energy, the shipper could be considered a secondary play on the energy sector.

The No. 1 reason investors often flock to the shipping stocks are the unbelievably high yields. Frontline's current annual dividend yield is about 14%, among the highest of its peers. Anytime a stock offers a yield of this magnitude, investors must realize there is added risk due to the possibility of the dividend yield dropping. If the yield were to fall, it could result in a short-term panic-selling frenzy.

Fundamentally the stock trades at a reasonable price-to-earnings ratio (P/E) of about 7 based on 2007 estimates. It is not uncommon for shippers to have a P/E in the single digits, though FRO is currently trading at a 50% discount to one of its close competitors, Teekay Corp (NYSE:TK).

The upside and risk with Frontline is two-fold: the high dividend payout and volatility in oil prices. While the dividend yield will attract buyers, the slim possibility of a drop in yield increases the risk of a selloff. Because two-thirds of the company's vessels trade on the spot market, they get higher rates than a time charter. But on the flip side, the price is often determined by the price of oil. The company can weather a short-term dip in oil; however, a long-term downtrend would directly affect this stock's value.

Spanish Oil
When we think oil, Spain and Argentina are probably not at the top of the list of investable countries. I think that is about to change. Repsol YPF (NYSE:REP) is a Madrid-based integrated oil and gas company that operates in over 30 countries. The company is currently one of the 10 largest private oil companies in the world and the largest private energy company in Latin America in terms of assets. Two countries where REP is clearly the leader are Spain and Argentina.

The first quarter numbers were not the greatest for REP, as the operating income in the exploration and production division was down 32% due to lower oil prices, the strength of the euro and higher costs. The silver lining is that the chemicals division compensated for the weakness with a gain of 126% in operating income. The exposure to both oil and chemicals makes REP attractive because both sectors are in long-term uptrends that can continue for a few years.

Based on the 2007 earnings estimate of $2.93, the stock is currently trading at a P/E ratio of about 12-times, which is comparable with other foreign oil companies of similar size. The upside of REP has to do with the current attractive valuation coupled with the recent pullback. After trading at an all-time high of $41 in July the stock pulled back 17% before bouncing off a critical support level at the 200-day moving average and is now offering a high reward-to-risk setup. (To learn more, see Support & Resistance Basics.)

The risk surrounding REP will be tied directly to the price of oil. If the demand for the commodity surprisingly subsides, it will likely send the stock down. My outlook on crude remains bullish over the long-term and therefore REP should continue to benefit from rising prices.

For related reading, check out Surviving Bear Country.

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By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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