Two weeks ago we held the monthly joint web chat for subscribers of The Energy Strategist (TES) and MLP Profits. In the span of just over an hour we received about 90 questions and comments. We had a number of questions remaining at the end, most of which I have now answered in the previous two issues of The Energy Letter and MLP Investing Insider. However, there were three more than I saved just for Energy Strategist subscribers.

Q: What do you think of APA?

Over the past few years, Apache (NYSE: APA) has been shifting more of its oil and gas production to North America, and also emphasizing the more lucrative liquids production. The company has been particularly focused on the Permian Basin, and to date results have exceeded projections.

Apache’s portfolio rebalancing through Q3 2013. Source: Apache Investor Presentation

Investors have been slow to recognize value in Apache’s moves, its share price lagging that of most competitors. Over the past 12 months, shares are up less than 6 percent following the recent across-the-board retreat for domestic oil and gas producers.

Apache recently stopped using fresh water for fracking operations in the Wolfcamp shale in the southern Permian Basin. In much the same way that Cenovus Energy (NYSE: CVE, TSE: CVE) uses brackish water to produce bitumen in Alberta, Apache extracts brackish water from an aquifer, treats it, uses it for fracking and then recycles the fracking wastewater. Not only does this approach lower the environmental impact of fracking, but Apache reports that it also produces large cost savings over using fresh water and then having to pay disposal costs.

Overall, Apache looks pretty undervalued to me. It hasn’t had the huge run-up seen by some of its Permian competitors, but then it also didn’t see as significant a correction in November. Looking ahead, Apache looks poised to outperform.

Q: I recently sold half of a three-year-old position in SDRL and bought Ensco.  What do you think of the relative benefits between these two?

One of the questions we frequently encounter is whether Seadrill (NYSE: SDRL) can maintain a dividend in the 9.5 percent range. In comparison, Ensco’s (NYSE: ESV) is a bit over 5 percent. That’s not too shabby, but Seadrill’s share price this year has also significantly outperformed Ensco’s. At present, Seadrill is up 6 percent year-to-date while Ensco is down 6 percent. At one point the discrepancy had become very large; in October Seadrill was up 30 percent year-to-date while Ensco was still down 6 percent.

This of course means that Seadrill has suffered a fairly large correction; down nearly 20 percent over the past three months while Ensco has held steady. So if you sold your position prior to the big decline, your timing was very good indeed. Seadrill’s correction was part of an overall decline in oil prices over that period, but more specifically Q3 earnings for Seadrill came in under expectations. This has led some to conclude that the dividend isn’t in fact sustainable; that a few more quarters like this and it will have to be cut.

During Seadrill’s most recent quarter, revenue was up 17 percent year-over-year and next year’s slate of new builds already under contract looked promising enough for Seadrill to boost the dividend by 4 cents to 95 cents a share. Seadrill noted that the market was adequately supplied in 2013 and could be oversupplied in 2014, but that the oversupply “will be acutely felt by lower specification assets while Seadrill is positioned in the high end of asset classes where utilization is likely to remain at 100 percent.”

Regarding the relative merits of the two, they are pretty close. Seadrill has outperformed Ensco over the long term, but I can understand the concerns about the dividend. I would favor Seadrill as a more aggressive investor willing to hold for a longer period of time, while Ensco looks like a good bet for more conservative investors.

Q: Your thoughts on XEC?

Cimarex Energy (NYSE: XEC) is definitely on our radar, and one that we have been watching closely. Cimarex is an oil and gas E&P company with operations focused in the Mid-Continent region (specifically Oklahoma, the Texas Panhandle, and southwest Kansas) and the Permian Basin. Last summer the company was listed (along with several of our favorite portfolio companies) in Deutsche Bank’s Top 10 List of Oil and Gas Stocks to Buy with a price target of $99, which it took out in early October. The share price is up 80 percent year-to-date.

The company is sharply growing production in the productive Permian Basin, but it is doing so without taking on large amounts of debt. Cimarex has a substantially lower debt level than Permian peers, although it has left open the possibility of taking on more debt to accelerate the drilling program in 2014.

Cimarex’s production profile through Q3 2013. Source: Cimarex investor presentation

On top of its solid fundamentals, Cimarex pays a small dividend, yielding 0.5 percent. Cimarex is covered by 28 analysts, who on average rate the company a Buy with a $115.50 target (11 percent above the current price). Given the strong advance made by the company’s shares in 2013, I wouldn’t be surprised to see it trade sideways for a while as production catches back up. I agree with the analysts who think Cimarex rates a Buy, but I would try to catch it at a bit of discount from where it is currently trading, and I wouldn’t be a short-term buyer as domestic oil producers still face the risk of a pullback if oil prices are soft next year (as I think they will be).

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