Most energy stocks are priced far below the value of their assets, leaving the door open for investors to profit greatly from the recent energy boom, according to Joseph Dancy, a venture capitalist and law professor at Southern Methodist University, speaking at an energy media breakfast on Thursday.
Over the last two years, publicly traded energy stocks have under-performed relative to the Standard & Poor’s 500 Index, and most have been given ‘buy’ ratings by analysts, Dancy said, reflecting a market disconnect between the value that the energy boom has created for these companies and the price investors are willing to currently pay.
Some of the reason for the disconnect is an emotional bias against the dirty world of oil.
“Energy has a connotation – it is dirty, it is old, it is crude, it’s environmentally non-sensitive,” Dancy said. “You listen to Bloomberg, and they are talking about Facebook and Apple phones. All those companies are much more modern – they have a perception that they are growing faster, and that they are non-polluting and environmentally friendly.”
But the perception that oil companies are lumbering with antiquated approaches is a misguided bias, Dancy said.
“In reality, energy probably uses as much computing power and technology as any other industry,” Dancy said. “It is growing faster than most technology companies and has better margins, growth prospects and earnings other than other sectors.”
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Within the energy sector, small and midsized companies are the most undervalued, with share prices trailing the S&P 500 Index average by about 20 percent. Concerns about a global oil glut and questions about potential reserves have helped dampen oil prices, with some believing that the shale boom may be overblown.
“There was a concern about the viability of these shale plays and how long the reserves would last at current production rates,” Dancy said, explaining that the natural gas plays were initially estimated to have a severe decline rate. “But the decline curves are much more robust than the naysayers had said they would be. For a lot of the reserves, they are actually adding to the estimates, as the engineers feel more comfortable that they will produce longer than they had originally thought.”
The drop in natural gas prices over the last five years has also made some investors skeptical over investment in oil, Dancy said.
“What most people are concerned about is the concern that crude oil will be much like natural gas in terms of a glut,” Dancy said. “That is not going to occur because oil is a global commodity. It is easy to produce and you will get global prices.”
Other reasons that investors are undervaluing energy stocks are concerns about tax policies, questions about environmental and regulatory policies and the possibility of an overall economic slowdown.
It has resulted in small companies like Saratoga Resources Evolution Petroleum being priced at less than half the value of their net assets, Dancy said, an opportunity for investors that only comes about once a decade in this sector.
Dancy said that his investment partnership owns both these stocks.
“Once you have these discrepancies between share prices and asset prices, they close in a way that is very beneficial for investors,” Dancy said. “The energy sector, once it is recognized what it is really worth, it will be a very good sector to be invested in, and it will drive merger and acquisition activity probably within the next six months.”