Energy investors that remain concerned about the possibility of a second economic contraction, but still want to have equity exposure, should look for companies with stronger balance sheets that are sure to emerge intact from a double-dip recession.
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Many companies didn't survive the last recession as falling cash flows along with large and maturing debt loads took its toll on a number of public companies. The energy sector is particularly susceptible to this due to the cyclical nature of both the business and commodity prices.
Exploration and Production
Devon Energy (NYSE:DVN) has a solid balance sheet that has been enhanced over the last year with the proceeds of a large restructuring program initiated by the company at the end of 2010. This program involved the divestiture of offshore and international properties and netted approximately $8 billion in after-tax proceeds.
Devon Energy ended the second quarter of 2011 with $7.9 billion and $6.7 billion of cash and short-term investments, bringing net debt down to $1.2 billion. Devon Energy's net-debt-to-capitalization ratio of 5% is conservative and should lead to a less volatile stock price relative to more levered companies.
Evolution Petroleum Corporation (NYSE:EPM) goes one step further and has no debt on its balance sheet as of the end of the company's third fiscal quarter. Evolution Petroleum Corporation is active mostly in Texas and Louisiana and has the majority of its proved reserves and production from an enhanced oil recovery operation at the Delhi Field in northern Louisiana.
Unit Corp (NYSE:UNT) also has a better balance sheet than many of its peers, with a debt-to-capitalization ratio of 12% as of June 20, 2011. The company has nothing drawn on its credit facility and only one debt issue outstanding with a maturity date in 2021. Unit Corp is involved in exploration and production, and contract drilling and midstream, giving investors exposure to three separate areas of the energy complex.
Dril-Quip (NYSE:DRQ) has $79 million in debt and $250 million in cash as of the end of the second quarter of 2011, bringing this oil services company into a negative net debt position. Dril-Quip is a supplier of subsea products and equipment and has no leverage to the North American drilling cycle, which tends to be more cyclical during downturns than the offshore cycle.
The Bottom Line
Companies with little or no debt are usually safer plays during a recession, but investors should understand that the financial measures used above are incomplete as well as static and backward looking. A more comprehensive examination would involve additional measures of leverage and one that is prospective for the company's net cash flows over the next year. Also, during market panics, investors tend to sell off all stocks in a cyclical sector, regardless of individual fundamentals, which means there are few places to hide in the energy sector. (For additional reading, take a look at A Guide To Investing In Oil Markets.)
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