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For oil stock profits, companies doing exploring draw some favor

A few integrated and many producing petroleum companies are posting profit gains in 1981. But the higher profits come from companies pulling in fresh earnings because of successful exploration in 1979 and 1980.

Exploration success is continuing this year for many of these same companies, and Sam R. Bright Jr., an analyst with Rauscher Pierce Refsnes Inc., a Dallas securities firm, considers that companies committed to exploration are the most attractive sector for common stock investment.

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Two other areas are also appealing by historical standards. One is companies owning large gas reserves. Mr. Bright suggests that with the expected gas deregulation in 1985, the companies will benefit from higher prices. He sees gas prices moving from nearly $2.70 to more than $5. As average prices rise, old low-price contracts will be renegotiated with increasing ease, he predicts.

The second area is a large group of asset-rich companies which he says are at "almost unprecedented valuation lows" because of the investment community's pessimism over the oil supply-demand outlook and competition from currently high interest rates.

In Bright's opinion, "many of these companies will outperform the most popular growth stock favorites during some period within the next three years, because of improvement in the oil industry outlook and correction of the excessively skewed valuations in the present market."

He uses two measures of valuation for oil companies: (1) current market price per common share as a percentage of the estimated breakup or sale value; and (2) a different view, in which the value of all assets is ignored (considered zero) except oil or gas reserves inside the United States.

The current market value of common stock and the company's long-term debt were added and this total "cost" divided by the number of US barrels to get a "cost per US barrel," ignoring the value of allm the company's other assets. Gas reserves were converted to equivalent barrels on a Btu (British thermal unit) basis.

Through his valuations, Bright estimates the market price for the average US oil barrel at $12.45. By that standard and with no value assigned to other assets, he spots several companies selling for a third or less of the sale value of US reserves.

He maintains that the primary risks in oil common stocks are the length of time for market pessimism about oil market conditions to pass and to a lesser degree the duration of high interest rates. "We strongly suspect that current market price levels offer attractive rewards for those who can afford these risks," he says.

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He picks seven companies with sales in the $3 billion to $30 billion range as favorites. Atlantic Richfield and Standard Oil of Ohio offer concentrated investment among large companies in secure domestic reserves, he says. Arco and Sohio are also the cheapest among the six biggest companies, at $3.08 and $3.17 a barrel, respectively, under the Bright formula, although without Alaskan gas Arco would be $4.38 a barrel and Sohio $4.10 a barrel higher, but still among the cheapest.

The leading discoverer of domestic reserves in recent years is Standard of Indiana, "definitely moderately priced, if not among the lowest priced in the large-company group, at $5.68 per barrel," Bright notes. A close rival for exploration leadership has been Standard Oil of California, available at nearly half the cost of Standard of Indiana, at $3.35 per equivalent domestic barrel.

Texaco is runner-up for cheapest, measured by market price as a percent of liquidation value, "and is well into a major redirection by an aggressive new management team, whose efforts may someday offset inherited problems." Its per-barrel equivalent is $4.56.

Bright terms Shell ($5.24 a barrel) a "well-balanced, well-managed, wholly domestic company with good exploration results recently and moderately priced on a per-barrel basis. Phillips "has potential to develop as a special situation," he adds.

"At 38 percent of the liquidation appraisal and $6.44 per equivalent domestic barrel, the latter figure ignores major North Sea reserves, a promising Ivory Coast discovery, a possible Santa Barbara Channel domestic find, and about 6 million domestic acres held for exploration," he says of Phillips.

Oil stocks through the early '80s may remain heavily discounted, but the level of discounts resembles the unusual undervaluation of conditions in 1974-75 . Bright says the recent heated bidding for Conoco by alternate suitors shows that his view is shared by "more than one type of large company industrial management."

Smaller companies, he points out, are even easier to buy than giants such as Conoco. Still, rather than forecast a rapid buildup of sellout activity, Bright sees the odds favoring a "generally improved recognition" of market values for oil shares, as happened in similar previous circumstances.

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