My latest post is up at RealMoney.

I think there is still quite a bit of run left in the energy bull market. That belief has led me to some good picks, such as Patterson Uti (PTEN) and Flowserve (FLS) , as well as one bad one, Frontier Oil (FTO) . My models recently brought W&T Offshore (WTI) into focus, and I’m thinking it is more likely one of the former than the latter.

The stock shows up very well in the Stock Market Beat models:

• Earnings momentum score: 1 (Positive)
• Earnings quality score: 5% (Positive)
• Price momentum score: 37% (Positive)
• Free cash flow yield: 10.6% (Positive)
• Return potential: 16.8% (Positive)

Capital expenditures are ramping up, which will hurt free cash flow in the near time. If the expenditures are as successful as those of the past, however, the cash should start flowing again after a year or two.

...

This post contains additional content for Stock Market Beat premium subscribers. Login to view.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

Just three months ago I said it looked like Patterson-UTI (PTEN) was poised to profit from an eventual rise in oil prices. I liked the fact that its free cash flow yield was much higher than those of its peers Helmerich & Payne (HP) and Grey Wolf (GW - Annual Report). I also said the momentum is clearly with HP, and I wouldn’t blame anyone for wanting to let that winner ride.

Since that time, all three stocks have posted solid gains, and the ranking has largely met my expectations: 57.6% gains for Helmerich and Patterson, and a “mere” 43.7% for Grey Wolf. Meanwhile, the S&P 500 has risen just 4.3%.

With more than 53% outperformance in three months, and a stock price that is way out in front of its 50 day moving average, I think it’s time to take profits on Patterson. The recent relative performance now means its free cash flow yield is less than that of Grey Wolf. While there is a possible catch-up play in Grey Wolf, my inclination is to stay on the sidelines for now.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

My latest column is up at RealMoney.

I dissect the jobs report to see which industries are showing the best/worst growth in new hiring, on the thesis that companies in these industries may present investment opportunities.

The fastest growing industries are restaurants, hospitals, mine services, machinery, and oil & gas extraction. The worst were transportation equipment and a plethora of housing-related sectors.

Disclosure: At time of publication, William Trent owns shares of Starbucks (SBUX).

Disclosure: Author is long Starbucks (SBUX) at time of publication.

My latest column is up at RealMoney. Here is a summary:

Government economic reports can do more than just indicate the state of the economy. Since many of the reports include industry-level data, digging deeper in the reports can help investors find specific industries to consider more closely. For example, the Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis.

Since I wrote about the PPI data in September, the pricing power has shifted to some different industries. Therefore, I thought an update would be in order.

Some of the industries that look interesting are petroleum refineries, industrial gases, computers, computer storage devices, and line-haul railroads.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned.

photo credit: Gastev

This article is a reprint of my February 19, 2008 RealMoney column

After peaking above $49 per share last year, refiner Frontier Oil (FTO) sunk to intraday lows in the $20’s last month before starting a rally on the news of Valero’s (VLO) positive outlook on the latest conference call. My biggest surprise, looking over the data for Frontier and the industry, is why it hasn’t rallied even more.

First of all, Valero indicated that “Current industry conditions are setting the stage for rebounding gasoline margins.” If true, that would be equally positive for Frontier and others. Not that I don’t believe Valero, but I thought a check of the PPI industry statistics could provide an unbiased second opinion.

Petroleum Refineries PPI, 12-Months Percent Change

Source: Bureau of Labor Statistics

Lo and behold, year/year price increases for petroleum refineries have suddenly shot straight up. If that doesn’t set the stage for rebounding margins, what will?

Hardly a week later, there was actually speculation that Valero would buy Frontier. However, according to the Reuters article, Fadel Gheit, an oil analyst with Oppenheimer & Co, also questioned the rationale behind Valero buying Frontier, especially since Valero has already sold one refinery and has said it would sell two and maybe three others.

Sold a refinery, you say? That sounds like a ripe opportunity for a comparables analysis to see how Frontier’s valuation stacks up against an arms-length transaction between industry experts. And at first glance, Frontier doesn’t come out looking so hot.

Valero’s Lima, Ohio refinery was sold last year to Canada’s Husky Energy (HSE.TO) for $2.1 billion. Lima’s 165,000 barrel per day stated capacity being quite close to Frontier’s total capacity of 162,000 barrels per day, the comparison initially looks valid. And with Frontier’s enterprise value at $3.6 billion, the implications could be that Valero’s management got ripped off, Frontier is overvalued, or the assets aren’t really comparable.

Valero is a good company, and I don’t believe its experienced managers got ripped off. The other two theses can be tested by comparing the assets. According to Husky’s road show slides, it seems Lima was something of a fixer-upper. Running well below the stated throughput, its sales and profitability were not close to those of Frontier. Taking the 2006 performance as an example, I was able to compare the valuation relative to various fundamental metrics.

Sources: Company filings, compiled by William A. Trent

Although Frontier looks more expensive on the basis of throughput or sales, its full-throttle capacity utilization has resulted in a far more efficient operation. As a result, Frontier is cheaper based on EBIT or EBITDA, which are the valuation measures most frequently used in the industry.

Of course, running at full capacity also means there is little room for further improvement other than through the commodity prices themselves. Even considering a fair valuation, that could mean there is significantly more downside risk than potential upside.

I also looked at Frontier on the basis of my favored valuation tool, its free cash flow yield. In this regard, Frontier’s yield on trailing free cash flow is about 6.2%, which is sufficiently above the yield on five-year Treasuries that I don’t need significant growth to justify a purchase. The potential rebounding margins, in other words, is a bonus.

Disclosures: None

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

The following is a reprint of my January 17, 2008 RealMoney column.

For the last several months, as most of us were complaining about the price of oil at the pump, oil drillers like Patterson-UTI (PTEN), Helmerich & Payne (HP), Grey Wolf (GW - Annual Report) and Unit Corp. (UNT) have been seeing customers push back on the rates they charge for operating rigs. Morgan Keegan analyst J. Michael Drickamer described the fourth quarter as “choppy.”

The latest PPI report backs up that assessment. Despite the rising oil price, price increases for drilling equipment have been quite constrained – in the mid single digits compared to a year ago.

Year/Year Price Change for Oil and Gas Equipment

Source: Bureau of Labor Statistics

Helmerich & Payne has survived the choppiness relatively unscathed, as its FlexRig design is more efficient than traditional rigs and is allowing for higher dayrates. Patterson has been the dog of the group, shedding nearly half its value over the last two years.

From a perfunctory look at valuation using traditional measures such as P/E or Price/Book, Helmerich & Payne and Unit look like the cheapest stocks, while Grey Wolf has the best growth potential. The momentum is clearly with HP, and I wouldn’t blame anyone for wanting to let that winner ride.

Source: Yahoo! Finance, William A. Trent

But Helmerich’s success has come at a significant cost, with capital expenditures exceeding the cash flow provided by operating activities over at least the last four years (free cash flow has been negative). It has made up this gap by piling on half a billion in new debt. Unit has been in similar straits. Thus, my preferred valuation metric of free cash flow yield (free cash flow divided by enterprise value) is rendered meaningless for these companies.  Suddenly, the lower P/E multiples start to make sense.

There are several reasons I like looking at the free cash flow yield. For one thing, doing so avoids some of the most common earnings management ploys. For another, cash represents the real money the company has available for growth, acquisitions, dividends and share repurchases.

And Patterson has been doing plenty of share repurchases. During the three months ended September 30, 2007, the company purchased 2,275,000 shares of its common stock and the Board has authorized approximately $200 million more for repurchases. These buybacks have reduced the share count from 170 million in the first nine months of 2006 to 156 million in the same period of 2007. That is a 10% gain in earnings per share for any given level of net income.

Unfortunately, the net income has been declining due to the lower rig utilization. This is not expected to reverse soon, as analysts are currently expecting revenue to decline a further 5% in 2008. That’s an improvement from the 17.6% decline in 2007, though, so value investors may want to start looking for the bottom around here. The big fear, of course, is the economy. If demand for oil slows, will prices collapse?

I don’t think so. For one thing, most commodity cycles are driven by supply rather than demand. While a reduction in economic activity may have a short term impact and keep a lid on prices, the longer-term outlook is still driven by long-term economic growth and the growth in supply. If $100 oil doesn’t bring new rigs on line, eventually the demand will catch back up to supply and the price of oil will go higher.

The latest inventory data notwithstanding, oil inventories are at a historically low level relative to sales. A downturn would allow inventories to be rebuilt to something in line with the historical average, but in the long term supply - not demand - will dictate price.

Oil Stocks: Days Sales in Inventory (Including SPR)

Source: Energy Information Administration, compiled by William A. Trent

A recent Howard Simons article on what really moves energy stocks showed that Patterson is one of the most sensitive names to crude oil prices, natural gas prices, and even the crack spread. Little of that has applied in the last two years, of course. But it might be well worth speculating that in the long term, Patterson again benefits from the higher energy prices.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

With oil reaching new highs on the back of the oil inventory drawdown, I decided it was time to update my chart on the topic.

People who know more about energy investing than I have objected to my naive supply/demand analysis, so for now I make no attempts to draw conclusions. I’m still not convinced, but will keep my trap shut unless I can back it up with more substantial data.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

I decided to take a look at what some of the largest companies by revenue are saying about their business.

All looks well at General Electric (GE - Annual Report).

The second quarter orders were a record, up 32%; we grew our backlog. We’ve got very strong global demand, up 21% in revenue. We continue our focus on margin expansion. Year-to-date we’re up 120 basis points; we’re up 70 basis points for the quarter. This is a big initiative inside the company, and one that we’re committed to….

Globalization and emerging markets, GE is very advantaged in these markets and these are just booming right now.

Infrastructure continues to be a real solid point for the company. Demographics as it pertains to both global growth and some of the action in GE Money is great. All of our focus on ecomagination, energy and investment/reinvestment is very solid.

If you look at what’s the same, we still see high liquidity in the marketplace. The U.S. consumer seems fine. Unemployment is at low levels, and we’re not seeing really any warning signs with the U.S. consumer….

On balance, we think we’re well-positioned in this environment. There’s no big surprises, and we feel like we’re in good shape as we look at the rest of the year.

(Excerpt from full GE conference call transcript)

Exxon Mobil (XOM - Annual Report) describes several reasons why investing in new projects can be risky, which helps explain why they haven’t invested as much as some would like (and why prices for oil are likely to remain high.)

Although increased volumes from the recent project start-ups in Russia, West Africa, and Qatar more than offset natural field decline, liquids production fell by 34,000 barrels per day, or 1% from the same quarter last year due to entitlement and OPEC quota effects in Africa….

ExxonMobile’s affiliate in Venezuela was not able to reach the agreement on the formation of a mixed enterprise and on June 27, 2007, the government took over our interest in the Serene rural project….

(Excerpt from full XOM conference call transcript)

And they didn’t even get to hurricanes, Iran, Iraq or terrorism. Makes you want to run out and drill an exploratory well, doesn’t it?

General Motors (GM) hopes to build a house of BRIC:

It was actually a very good quarter for other regions. Strong growth outside North America in the quarter, adjusted profitability of close to $700 million, $1.1 billion year-to-date. Revenue up 16%, share up 0.2%. I remind you our revenue does not include our business in China, as we carry it on the equity method so you would not see the growth in our business in China showing up in revenue. So this is really only on a consolidated basis.

Europe reported its best quarterly results since the second quarter of 1996, strong structural cost performance and favorable pricing. LAAM continues to leverage, it can only be termed explosive growth, reported the best quarter in ten years in both revenue and profitability. GMH reported a record second quarter adjusted net income with continued growth in China, India, and South Korea, as well as some improved performance in Australia….

Russia is a very fast-growing emerging market. 2.5 million units. It’s actually fast approaching one of the largest markets in Europe, actually, getting very close to France, Spain, Italy in terms of its size; and the U.K., as you can see. Our market share is up almost 4 points in Russia year-to-date.

Actually, we’re running behind in Brazil, we’re trailing in terms of market share in Brazil, but the driver of that is the market is up 50% in terms of its SAAR in the quarter. I would say the challenge in LAAM today is to keep up with the markets growth….

China, you can see the SAAR is up from 6.7 million to 8.3 million units. Our market share has not kept pace, so we’ve had some competitive pressures there, but nonetheless we’re still running pretty strong in China.

(Excerpt from full GM conference call transcript)

However, as if they needed any more challenges, they have subprime exposure that needs to be worked off.

ResCap lost over $900 million in the first quarter. We said that in the second quarter we expected that losses would narrow considerably and we expected better results. We did see that. Nonetheless, the $254 million is still a substantial challenge, it’s the largest business challenge for the GMAC management team in terms of restoring that business to where it needs to be. But it’s good to see the declining losses. We have sharply reduced our non-prime production, our non-prime exposure across warehouse lending, across some of our builder businesses. You saw run-off in the non-prime portfolio held for investment. We expect our run-off in the held for investment portfolio to be about $15 billion this year. So we’re basically reducing our exposure to non-prime and at the same time, we are seeing increased service fee income and lower structural costs.

So I would say the challenges continue here, but the first step in addressing the challenges is to stop deteriorating.

(Excerpt from full GM conference call transcript)

Citigroup (C - Annual Report) is also feeling the heat.

Net credit losses were up by $259 million, driven primarily by our global consumer business.

In consumer, key drivers are higher balances from organic portfolio growth and acquisitions; continued deterioration in the second mortgage portfolio; and the impact of the gray zone in Japan. In markets and banking, we continued to see a stable credit environment.

The third component is a $465 million net increase in the loan-loss reserve. There were two major drivers of this increase. First in the U.S. Cards business, the increase was driven by a change in the estimate of loan losses that are inherent in the portfolio. It is important to note that the underlying credit metrics have remained largely stable in our cards business. This reserve build reflects our focus on staying ahead of the visible credit trends, by considering as many factors as possible in establishing our reserves.

Second, in the international cards business, portfolio growth and seasoning and the impact of recent acquisitions resulted in higher reserve levels.

(Excerpt from full C conference call transcript)

Wal-Mart’s (WMT - Annual Report) customers are feeling the pinch.

Consumers today are pressed by a number of factors. Higher energy, higher gas prices and higher interest rates are all stretching their paychecks. Families with school-aged children are expected to spend more than $500 this year on back-to-school products. Our price campaign is designed to make a difference for families by saving them money where it counts most: on items like backpacks, pencils and socks. We’re encouraged by the response we’re seeing in back-to-school in August. 14 states have tax-free days during the start of this month. In addition, several states have delayed some school openings and we expect the trend we have seen with other seasons to continue. People are buying closer to the event.

As reported by other retailers, we’re experiencing similar trends in soft sales of home products driven by the slow down in housing. In addition, Wal-Mart’s softness in the home and apparel categories has been compounded by the difficulties we have had this past year and have shared with you. The result is that home and apparel remain soft through the second quarter. We’re starting to see some improvement in certain home categories this month and we are pleased so far with the sales results and customer response to the test of the New Home that we are piloting in several markets.

We continue to see pressure in all areas of apparel and continue to take pricing actions needed to sell through our inventory. We’re seeing some positive trends in sleepwear and men’s sports apparel. In the children’s areas, licensed apparel is picking up momentum and as I mentioned earlier on, we do expect our kid’s apparel categories to rebound this month.

(Excerpt from full WMT conference call transcript)

I guess it is not surprising that the top companies are seeing an outlook as mixed as that of the overall economy.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

I have frequently heard that oil inventories aren’t very important because refining capacity is the gating factor for most products. According to a recent MSNBC article:

There hasn’t been a new refinery built in the U.S. since 1976, the result of extremely tight environmental restrictions, not-in-my-back-yard community opposition, and the high cost of new construction. Used refineries currently sell for about 30 to 50 percent of the cost of building a new one, so it’s cheaper to buy an old refinery and upgrade it. Or squeeze a little more gasoline out of the refineries you already own.

Expansion of refining capacity is also made more difficult because oil refineries are a lot more complicated to build and operate than your average widget factory. For starters the raw material — crude oil — has many different properties, from thickness to sulfur content, so not all refineries can blend just any barrel of crude.

You would think that in this type of environment the refineries would be able to charge whatever they like. But recent PPI data suggests otherwise.

After a prolonged period of significant price gains, the year/year change in refinery pricing power dipped into negative territory early in the year and has been relatively flat since. Are the glory days over or is this a temporary lull? For help answering this question I turned to the recent conference calls from three of the larger companies that get most of their business from refining and marketing: Sunoco (SUN), Valero (VLO) and Holly (HOC).

First, speaking to refining margins, as we did last quarter, if you look at slides 6 to 9, we have included some detail of the realized refining margin versus our reported market benchmark for each of our geographic refining regions. Rather than walk through each slide in too much detail, let me make a few summary comments.

In the Northeast, our realized gross margin for the quarter was $12.32 a barrel, which was up about $0.75 a barrel from last year’s very strong second quarter, and was also about $0.73 a barrel better than our standard 6321 benchmark. On the input side, realized crude costs in the second quarter were $1.66 a barrel higher than our Dated Brent plus $1.25 a barrel benchmark. So still reflective of a very expensive market for light sweet crude in the Atlantic basin, but improved from the first quarter of this year….

If I can turn now to the MidContinent region, where industry downtime had a more significant market impact, our realized gross margin in the second quarter was $22.14 a barrel, up over $7 a barrel from the second quarter of last year but about $6 a barrel lower than our standard WTI based 321 benchmark. Again, on the crude side, actual crude costs were $2.17 a barrel above the WTI plus $0.75 a barrel marker, as WTI continued to be a weak relative benchmark.

Additionally, the price of Canadian syncrude, which accounts for about half of our crude slate at Toledo, traded at an increased premium to WTI during the quarter, due largely to upgrade or maintenance and other downtime among Canadian producers.

On the product side in the MidContinent, our realization was almost $4 a barrel below the benchmark. This correlation, also seen in last year’s second quarter, is fairly typical of periods when gasoline crack spreads are very strong. This is primarily because the 321 marker we use implicitly assumes that two-thirds of our MidContinent refinery production is gasoline when it actually averages more like about a half.

So let me say in summary, putting all those numbers and relationships aside, clearly second quarter refining margins were very strong by any historical measure.

(Excerpt from full SUN conference call transcript)

Paul Sankey - Deutsche Bank

Hi everyone. I think we’ve just about hit all my questions, actually, but one that’s outstanding is the way the curves have shifted. Is there any meaningful impact for you from the moves that we’ve seen to backwardation in crude markets? As a follow up, any observations you could make about the fact that crude inventories, ostensibly, are quite high in the U.S., but we’ve seen obviously very high prices. At the same time, gasoline inventory is not super loose by any means, but a cratering of the price there - any observations you can make on those would be great.

Unidentified Company Representative

Well, I’ll speak to gasoline. Gasoline pries are very low. They’re very low on a historical basis. So the decline that we’ve seen in the margins there isn’t necessarily fundamentally driven. We’re entering the season where we will start blending butanes back in, and so we know that will have an effect on the inventories. Nonetheless, we go into that period with inventories at very attractive levels relative to previous years.

On the crude, the change in the market structure just means that we’re not paid to carry it right, so what we’ll do, what we always do, is we aggressively manage the inventory to the market structure, as we’ve done on the product side.

Paul Sankey - Deutsche Bank

Right, so I’d expect to see inventories continuing to fall, but maybe the price, nevertheless, staying high.

(Excerpt from full VLO conference call transcript)

Historically high industry-wide margins, our location advantage product prices, and record production levels at our facilities fueled the best quarter in Holly’s history.

The pure gasoline and diesel prices in our markets, due to the tight supply/demand balance in our Rocky Mountain and Southwest markets, combined with lower raw material costs to create historical quarterly average gas and diesel cracks at both plants.

Higher runs at lower cost black wax crudes at Woods Cross and a widening of the discounts for sour crudes run at Navajo, compared to compressed WTI prices versus similar worldwide crudes, helped drive down our raw material costs.

Our folks ran both plants at 99%-plus utilization rate, realizing the full benefit of the 2006 midyear expansion of the Artesia refinery and enabling a virtual full capture of the great margin environment experienced during the second quarter….

Although, as in other markets, our margins have reduced substantially in July and August from the lofty levels experienced during the second quarter, we remain extremely bullish on the refining industry fundamentals.

(Excerpt from full HOC conference call transcript)

Now I’m no energy expert, but it sounds to me like there is very little wrong with refining industry fundamentals. If anyone out there can enlighten me, please do so.

Disclosure: Author is long UNITED STS OIL FD LP UNITS (USO) at time of publication.

Large Cap Watch List (Track at Marketocracy) member Superior Energy Services, Inc. (SPN) today announced record net income of $70.1 million and diluted earnings per share of $0.85 on revenues of $396.8 million, as compared to analyst estimates of $0.80 on $377 million in revenue.

The company managed the growth without adding too significantly to the balance sheet. This suggests that cash flow from operations likely improved significantly, as did return on capital measures. Despite these improvements, however, the stock has stayed relatively flat for several months.

With a single-digit forward P/E multiple, I wouldn’t expect that to last much longer.