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Four energy stocks poised to charge ahead

In a beaten-down sector, select stocks offer strong upside potential.

Vikram Barhat 17 November, 2015 | 6:00PM
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Stakeholders and lobby groups in the U.S. and Canadian energy sectors have made little effort to hide their disappointment at U.S. President Barack Obama's decision to nix the cross-border Keystone XL pipeline project.

While we may not have heard the last of the $7 billion venture, the rejection is seen as likely to put a damper on energy stocks already reeling from the impact of low oil prices.

On a one-year basis, the S&P 500 Energy Index in the U.S. has swooned 18.72 %, while in Canada, the S&P/TSX Capped Energy Index is down 16.91% for the year to date, as of Nov. 10. The Alerian MLP Index, a leading gauge of large- and mid-cap energy Master Limited Partnerships (MLPs), was also down nearly 24% for the year to date, as of Nov. 11.

There remain, however, select down-but-not-out energy stocks at a substantial discount for those hunting for value. These companies have well-managed, diversified business mixes and rock-solid balance sheets to provide insulation during volatility, and offer strong upside potential for when improvement in demand and oil prices refuel the market, according to Morningstar equity research.

Spectra Energy Partners LP
Ticker SEP
Current yield 5.53%
Forward P/E 13.9
Price US$43.38
Fair value US$50
Data as of Nov. 12, 2015

 Spectra Energy Partners (SEP) owns and operates natural gas and crude oil pipeline systems, and natural gas storage facilities in the United States.

A recent Morningstar report by equity analyst Peggy Connerty said that while the oil and gas industry may not be past the worst just yet, names like Spectra are in "decent shape" despite the difficult environment in which they're operating. The company, which is 82% owned by its partner and parent, Spectra Energy, "has a solid balance sheet, decent coverage on their cash distributions and stellar management," the report noted.

"Wide-moat Spectra Energy Partners is one of the most defensive names in energy because it is entirely a tollbooth-based business model, with earnings generated by low-risk transportation and storage-related activities making up 100% of total margin," Connerty said.

The energy powerhouse doesn't have direct commodity exposure and faces minimal volumetric risk, since 80% of earnings before interest, taxes, depreciation and amortization (EBITDA) is generated by demand charges that are paid regardless of usage levels.

Connerty put the stock's fair value at US$50, implying a forward yield of 4.9%, and projected a distribution growth of 8% through 2017.

Magellan Midstream Partners, LP
Ticker MMP
Current yield 4.48%
Forward P/E 17.5
Price US$64.22
Fair value US$76
Data as of Nov. 12, 2015

 Magellan Midstream Partners (MMP) owns and operates pipelines and storage terminals in the Central and Eastern United States. Its assets transport, store and distribute refined petroleum products, crude and ammonia, and earn a fee-based stream of cash flows. Refined products make up 68% of the firm's operating margin, crude pipelines and marine terminals making up the rest.

Connerty regards the company as one of the more attractive names in the midstream sector. "Magellan Midstream also possesses a strong balance sheet and is positioned to increase cash distributions 15% in 2015 and a minimum of 10% in 2016," she said in a recent article. "The firm is primarily a fee-based business with margins generated by low-risk transportation and storage-related activities, which constitute 85% of total operating profits."

The partnership plans to spend more than US$1 billion on organic growth projects through 2016, which Connerty says should help it to "continue to consistently generate returns on invested capital well in excess of its cost of capital."

Magellan possesses the wherewithal to ride out the current market weakness and thrive when conditions improve, she adds.

Chevron Corp.
Ticker CVX
Current yield 4.64%
Forward P/E 23.0
Price US$89.99
Fair value US$107
Data as of Nov. 12, 2015

The second-largest oil producer in the United States,  Chevron Corp. (CVX) is an integrated energy company with exploration, production and refining operations worldwide. It also owns refineries in the U.S., South Africa and Asia.

Chevron's free cash flow, according to a Morningstar report, is expected to rise during the next five years due to improving oil prices, growing production and falling capital spending.

"Chevron's oil portfolio has led to peer-leading margins and returns on capital," the report noted, adding that new production from different regions of the world "will serve as the growth engine for Chevron in years to come."

The firm's competitive advantage lies in its ability to add value to refining operations through integration, says Morningstar sector strategist Allen Good. The energy behemoth also benefits greatly from its vast experience and expertise in deep-water exploration, which makes it more attractive to foreign governments in future bids for production-sharing opportunities, he adds.

The 4-star-rated Chevron's production growth is expected to accelerate in the coming years due to the startup of LNG (liquefied natural gas) and offshore projects. "We expect natural gas to contribute a greater share of production, about 39%, by 2017, compared with 34% in 2014," Good said.

Pembina Pipeline Corp.
Ticker PPL
Current yield 5.73%
Forward P/E 22.2
Price $31.12
Fair value $34
Data as of Nov. 12, 2015

 Pembina Pipeline Corp. (PPL) transports crude oil and natural gas liquids through its network of pipelines, which transports approximately 50% of Alberta's conventional crude oil and 30% of Western Canada's natural gas liquids. It also operates storage and blending facilities.

Management indicated it expects to reduce capital expenditures by approximately $225 million by the end of the year. Additionally, it expects to deliver more than $6.4 billion of secured growth projects including projects brought into service in 2015, according to a Morningstar report.

"While its midstream division dominates its operating margin, its gas plants and pipeline network are well positioned in some of Western Canada's hottest plays," said Stephen Simko, a Morningstar equity analyst. "Over the next five years we expect Pembina to deploy over $8 billion toward growth projects, heavily weighted to 2015-16." This will help generate a five-year compound annual growth rate for EBITDA of 16%, he adds.

"Increased revenue from the assets outside its marketing division is expected to bring about a shift in the share of operating margin by 2018," said Simko. "In particular, its operating margin from fee-for-service projects will shift from 67% in 2014 to 79% in 2018."

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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