Follow the Private Equity Money, Into The Energy Sector

One of the best ways to identify sectors that are undervalued, with huge rebound potential over the next few years, is to track the activities of private equity firms.

These investment funds tend to be long-term holders of companies and assets that are purchased when the sector is out of favor or financially troubled. Their focus on valuation and long holding periods are among the chief reasons that private equity and buyout funds have consistently been among the top performing investments over the past three decades.

Right now, private equity funds are becoming very interested in the energy sector. Kohlberg Kravis Roberts KKR just closed a $2 billion fund to invest in North American energy companies. According to the Preqin research firm, PE funds focusing on energy raised over $27 billion last year. And in a recent poll conducted by Ernst and Young, 77 percent of executives surveyed said they expect to see increased private equity interest in North American oil and gas deals.

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The co-chair of industry leader Carlyle Group CG recently spoke at the SuperReturn PE conference in Berlin -- and identified energy as one his firms preferred areas for new investment. "I think carbon-related energy is a great opportunity," he told investors, "because of what is going on in the United States, the energy revolution and the enormous demand for energy in the emerging markets.”

Swift Energy SFY is the cheapest North American oil and gas company right now. The company has not been able to get its mix of oil and gas reworked in favor of more profitable oil and natural gas liquids as quickly as investors had hoped -- and the stock has been pummeled, falling by 30 percent in the past year. The company owns some very attractive properties in the booming oil rich Eagle Ford shale fields, and the stock trades at just 40 percent of book value at the current price.

Investors with a private equity-like time frame should be richly rewarded, as conditions improve for this company over the next few years.

WPX Energy WPX was spun off from Williams Companies WMB two years ago, and is focusing on developing its oil and gas assets in North Dakota, Colorado and New Mexico. The company has also been hit by the weak pricing environment for natural gas, and the stock is down about 11 percent so far this year.

At the current price the stock trades at just 70 percent of tangible book value right now. They have a strong presence in the Bakken and Marcellus shale fields, and the stock should rebound nicely in the years ahead as the natural gas market improves.

One stock that may not show up on investors' screens is EXCO Resources XCO. The company is not trading below book value, but it is well below the $20 a share buyout offer made for the company back in 2011. They primarily focus on natural gas.

The company had approximately 70,000 net acres in the Haynesville and Bossier shale formations, 47,800 net acres in South Texas region for the Eagle Ford shale formation and 145,000 net acres in Appalachia region prospective for the Marcellus shale formation. The real story here is not just what they own but who owns their stock.

Investors Wilbur Ross, Howard Marks and Prem Watsa have all owned the stock for some time, and increased their position by a substantial amount in the recent rights offering. Combined, the three legendary value and distressed investors own almost 30 percent of the company.

Private equity money is flowing into the North American oil and gas sector. Although natural gas pricing has been weak, that should improve over the next few years -- as it becomes a larger part of the discussion about U.S. energy independence and cleaner fuels. Following the long-term money into the sector and picking up assets at large discounts to their book and intrinsic value should be very profitable for patient investors.