Stock pickers rarely do a proper analysis of sectors and stocks within each sector to find the hidden gems, or standout stocks that may provide much-needed diversification in a portfolio. In today's column we study the big end of the energy sector (XEJ), focussing solely on companies with a market cap of more than $500 million.

In looking at the chart below, you can see that the energy sector has mirrored the ASX200, highlighting just how much the sector is currently correlated with the broader market. If energy is up, the market rallies in tandem, although it has lagged marginally over the past few months.

Chart: XEJ 1 year price chart as at 2/12/2011, source: Yahoo 

Dominated by oil and gas and the biggest three companies Woodside, Origin and Oil Seach, the Energy sector is in fact made up of a range of different groups, including oil, gas, uranium and coal. Market gyrations aside, all four areas have had better years. None more so than uranium stocks, which have had a year to forget after the Japanese nuclear disaster sent investors running for the door. Energy Resources Australia (ERA) haemorraged 89% and Paladin dived 69%.

The big end of Energy town has suffered as well. The two biggest stocks by market cap - Woodside and Origin Energy - have also had their share of problems this year, which has seen their share prices slide 22% and 12% respectively.

In reality few of the larger energy plays have done well, with only eight out of the 23 stocks with a market cap over $500 million recording gains. The few bright lights have come from the likes of up and coming oil companies Aurora Oil & Gas and Beach Petroleum, both of which have more than doubled in value. Another oil and gas play Senex Energy has also gained strongly, up a healthy 56.4%.

Despite the fallout from the Japanese disaster earlier this year, some contrarian brokers believe that uranium stocks have been oversold and the future is looking brighter, with demand set to rise over the coming years. Others think you're best off employing your resources elsewhere, particularly in oil stocks.

US analyst Adam Hamilton from Zeal is bullish on both oil and uranium stocks, and he feels that the technicals for oil are looking bullish. "Its technicals are looking increasingly bullish...after recently bouncing out of a major correction, oil appears to be embarking on a new bull-market upleg.  If one is indeed brewing, speculators and investors alike ought to capitalise on this excellent buying opportunity in oil stocks." 

Sector: Energy (large caps)

Code: XEJ

1 year return: -14.3%

Largest Company: Woodside Petroleum (WPL), $26.9 billion market cap

Top gainers (12 months): Aurora Oil & Gas (AUT) +117.6%, Beach Petroleum (BPT) +102.9%, Senex Energy (SXY) +56.4%

Biggest losers (12 months): Energy Resources Australia (ERA) -88.6%, Paladin (PDN) -68.9%, Aquila Resources -36.2%

Top Gainer - Aurora (AUT)
Market capitalisation: $1,416 million
Price/earnings ratio:  42.1 times
Share price: $3.44

Chart: Share price over the year versus ASX200 (XJO)

With a stellar 118% gain over the past 12 months, Aurora Oil & Gas takes the top gainer's spot in the Energy sector from fellow oil and gas play Beach Energy, which also doubled to be up 103% for the year.

Brokers think there is more in the well for AUT, with CommSec, Euroz Equities and Patersons all placing buys on the stock. However, the stock has run hard and is approaching some of the brokers' price targets, so if you buy into AUT's story it may be wise to wait for a pull back before looking to get on board.

CommSec's price target is $3.70, a 7.5% premium to the current share price. "We see material reserves upside from completion improvements," it says. "Aurora also offers material production and earnings over the next decade (and) remains our preferred holding amongst the mid-cap oil and gas stocks."

Euroz Equities' John Bishop has a much higher price target at $5.21, saying that the company represents arguably the fastest growing oil and gas producer on the ASX. Bishop points out that production is ramping up and there is increased development drilling next calendar year. What's more, with the US$300m facility in place AUT is fully funded. "The market will be increasingly unable to ignore such an exceptional growth profile as data continues to build," he says.

Scott Simpson from Paterson has a more modest price target of $3.52. "The securing of a US$300m funding facility and the increased reserves certification are evident of the decreasing risk of the play," he says. Simpson likes AUT's long-term growth profile which will see production increase to 29kboe in 2019 and will have delivered approximately US$2bn in cumulative cash flow by 2020. "Improved well EUR’s and infill drilling will provide long term upside," says Simpson.

Biggest Loser - Energy Resources Australia (ERA)
Market capitalisation: $735 million
Price/earnings ratio:  96.54 times
Share price: $1.42

Chart: Share price over the year versus ASX200 (XJO)

After plunging 88.6% over the past 12 months, ERA is still searching for the bottom. A rally along with the rest of the market in October was all but given back in November and the stock is now wallowing back near the low hit in early October of $1.34 a share.

In short, brokers believe the stock is a basket case and that there's more pain to come. Nicholas Brooks from RBS Morgans has a sell on the beaten down uranium miner.  "The company recently announced a $500 million capital raising for works at its Ranger uranium mine in the Northern Territory," he says. "But we see significant risks around the upcoming wet season, difficulties in gaining a mining lease extension and potential upwards revision to several costs. Sell." 

Even after the rally in October brokers were warning investors off the stock. Citi sees it as high risk, while Credit Suisse, Macquarie and Merrill Lynch have an underperform on the company. UBS and RBS suggest investors flee while they can, with a sell on ERA.

Largest by market cap - Woodside Petroleum (WPL)
Market capitalisation: $27.0 million
Price/earnings ratio:  15.89 times
Share price: $33.52

Chart: Share price over the year versus ASX200 (XJO)

Australia’s largest oil and gas company, Woodside Petroleum (WPL), has dropped a staggering 34% since its 52 week intraday share price high of $50.85. Rather than seeing a bargain, some brokers are becoming more cautious on the oil and gas giant due to ongoing cost blowouts and project delays. Others see it as a takeover target.

Woodside produces LNG (liquefied natural gas); LPG (liquefied petroleum gas); natural gas; natural gas condensate; and oil.  The company holds interests in oil and gas assets in Africa, the Gulf of Mexico, Korea, and Brazil.  While Woodside’s oil operations account for only 23% of the company’s total production, oil brings in some 40% of revenue.

Cleo Nanni from Alpha Broking considers Woodside a long-term hold that can be part of any balanced portfolio. "Recent share price action has been disappointing and it’s due to rally based on company fundamentals," he says.

Shawn Uldridge of William Shaw Securities says that a takeover is on the table now that the restrictions on Royal Dutch Shell selling its remaining 24.27 per cent holding in Woodside Petroleum have expired. "All eyes are now on potential corporate action in this space...BHP has shown interest in fuels after its $12.1 billion purchase of Petrohawk Energy earlier this year," says Uldridge. "Other than Shell, WPL’s share register is wide open."

Les Szancer, Alpha Broking has a hold on WPL, and believes in the long term future for the company. "Oil and gas prices will go up at some stage and so will this company’s share price on the back of generating more revenue." Meanwhile Citi and UBS have buys, with Citi giving it a $41.96 price target.

Bob Kohut pointed out in a recent article on WPL that the real story with Woodside lies in its growth opportunities, especially in the LNG market. Bob pointed out that while the development of the Pluto LNG project has been slightly delayed, the revenue potential of Pluto is substantial. "As China and other Asian countries look for cleaner burning fuels, the LNG market is forecasted to explode in the near future." 

Rising Star - Beach Petroleum (BPT)
Market capitalisation: $1,595 million
Price/earnings ratio:  24.66 times
Share price: $1.44

Chart: Share price over the year versus ASX200 (XJO)

Beach Energy (BPT) has been one of the top performing stocks this year, up an impressive 108% for the year. It even shook off recent market volatility to surge 41% over the past six months; 15% over the last month alone. And the oil and gas minnow got the thumbs up from Citigroup following its strong September-quarter result; the broker raised its target price to $1.40. However the stock has since moved higher to $1.44, suggesting that it may be looking toppy. UBS and Macquarie's price targets sit at $1.45 mark.

Higher oil and gas demand and improved Cooper Basin access saw sales revenue rise to $151 million, a 39% jump on the previous period. Richard Batt, of Shadforth Financial Group says that another catalyst for further price increases is that BPT could easily draw predator attention from the likes of BHP for its gas shale wells in the Cooper Basin.

UBS says that upcoming drilling is likely to offer some upside, nevertheless it has a Neutral stance on the company because the share price is now looking fully valued. Macquarie has an Outperform rating on it, seeing positives in its Western Flank conventional crude project.

"While it’s encouraging to see Beach deliver strong operating cash flow and incremental reserves in the Western Flank area, the market will focus on news flow surrounding Cooper Basin shale," says Macquarie. "Expect the market to gain greater comfort from further encouraging drilling results, subsequently endorsed by a credible farm-in partner along with an independent resource booking."

We covered BPT in September in the article "Is This Rising Energy Star Right For Your Portfolio?".

 Industry Group - Energy*

 *Only stocks with a market cap of more than $500,000,000 have been included, there are  other small-, mid- and micro-caps in the  industry group.

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