Undervalued Energy Stocks: A Q&A With Ray Saleeby

The Energy Report:

Ray, your firm, Saleeby & Associates Inc., focuses on identifying companies with turnaround potential -- good firms that trade at a discount, but enjoy a solid customer base in hard-to-enter industries. Why?

Ray Saleeby: I buy stock in companies that are discounted to the intrinsic value of their operations. This differs from growth investing, which focuses on companies that outpace their peers for earnings. It differs from momentum investing, which attempts to time stocks on a short-term basis. My philosophy of value is more long term and contrarian. I buy companies when they are out of favor.

I handle $220 million ($220M) plus, of which about $100M is in the utility and energy industry. I buy a lot of utilities because there are tremendous barriers to entry to that sector. One does not find a gas utility popping up every other week! For the same reason, I like the construction aggregate business. And I absolutely love the water business. It's a resource that we're going to need forever. I also invest in defense electronics and oil and gas. There are also barriers to entry in the drugs and medical device space.

TER: Tell us about your research process.

RS: I have a library of 60,000 different research articles going back 20 years. I subscribe to about 60 different periodicals that provide financial reports and different types of information about various companies. I look at annual reports and presentations by companies. But before I buy a stock, I call up the management and ask detailed questions.

TER: How do junior gas and oil companies fit into this model?

RS: With the juniors, I take a very hard look at management. Does it have a track record of success? Are the managers personally invested in the firm? Second, I like companies that have a first-mover advantage in acquiring developable property. Clusters of wells provide economies of scale where drilling rigs can easily be moved around. Energy is a commodity business and access to capital is very important. And being a low-cost provider is crucial when dealing with commodities, as we never know when the market will fall. And, last but not least, I want companies that have a good hedging strategy. And for tax reasons, I look toward MLPs (master limited partnerships).

TER: Let's talk about discounted utilities with exploration and development arms. Where are the undervalued opportunities in that space?

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RS: One of the positives about operationally diversified utilities is that they can spin off resource development divisions. Now, a utility analyst is completely different than an oil and gas exploration analyst. With a spin-off, suddenly there are two different types of analysts following two related companies, and the new firm can get double coverage. Secondly, the new managers may have more incentive to produce than they did when they were operating under the parent company's top management. Also, utilities are heavily regulated; spin-offs are usually nonregulated.

The negative aspect of a divestment is that utilities are generally financially stable and can provide a cushion for commodity capital into its development divisions through boom and bust times. And the flip side of a spin-off in the analytical marketplace is that the typical oil and gas analyst does not generally understand how to analyze utility operations, whereas the typical utility analyst does not understand how to value oil and gas assets. So the double coverage can turn into a negative, a discount of real existing value.

TER: What are some promising names in this space?

RS: Questar Corp. (Exclusive Interviews page.

DISCLOSURE:
1) Peter Byrne of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Energy Report: Enbridge Energy Partners L.P.

3) Raymond Saleeby: I personally and/or my family and/or Saleeby & Associates Inc.' clients own shares of the following companies mentioned in this interview: Natural Fuel Gas Co., Questar Corp., QEP Resources Inc., Enbridge Energy Partners L.P., Enbridge Energy Management LLC, Energen Corp., MFC Industrial Ltd. and South Jersey Industries Inc. I was not paid by Streetwise Reports for participating in this story.