Right now, it doesn't take a lot of savvy to know oil is where the money is going, and natural gas is, at best, a couple of years out from a comeback. Most analysts' oil price decks are $85 to $90, but crude prices have been economic for some time. As a result, oil stocks are generally enjoying good performance.

Plenty of companies are trying to get into oil plays, if they haven't already, and the early movers may be close to full valuation. With long-term gas plays hitting the back shelves, investors have to look a bit harder to find companies that can deliver value in 2011. We asked E&P analysts where they see near-term value and growth in oil stocks. Some of their answers may surprise.

Getting oily

David Heikkinen, managing director and head of E&P research at Houston-based investment bank Tudor, Pickering, Holt & Co. LLC, takes several factors into consideration in finding E&P stocks that look promising for second-half 2011. The firm scrutinizes return on capital employed, value creation relative to finding and development costs, cash margins, and effectiveness in growing reserves and production on a debt-adjusted per-share basis. Heikkinen says the direction of these measures is what is important, not that the company ranks No. 1.

Many investors may not fully associate Chesapeake Energy Corp. with oil and liquids yet, despite its recent maneuverings into some key plays. But Heikkinen believes the previously gas-focused independent is headed for a liquids boom, and he has a $46 target for the stock.

David Heikkinen, managing director and head of E&P research, Tudor, Pickering, Holt & Co. LLC, thinks previously gas-focused Chesapeake Energy Corp. is headed for a liquids boom.

"Over the next four years, we have them growing their EBITDA (earnings before interest, tax, depreciation and amortization) to about $10 billion," says Heikkinen. "Some 50% to 55% of that becomes liquids driven." Not only is that dramatic liquids growth, but it picks up drastically in the second half, beginning with Eagle Ford production. West Texas contributions will follow shortly, with Niobrara production coming on later in 2012, he says.

"That liquids-production growth is driving higher margins into the company," aided by reduced finding and developing costs as the company transitions from leasing to drilling.

"From a value-creation standpoint, you are adding higher-value reserves, and that should drive higher margins and a higher PVI (present value index). Cash margins should improve."

Second, Heikkinen thinks Chesapeake is nearing a position where it will no longer need to issue shares or converts to fund production growth, benefiting shareholders. Finally, says Heikkinen, the company is setting expectations for production volumes and growth.

"What we have seen from every one of these gas companies that tries to go into oil is that expectations are they maintain the same growth rate, and they miss those expectations. Going from 40% growth to 25% builds some cushion into Chesapeake's growth plan."

But although the company's effective production growth has declined, that's not the whole story, notes Heikkinen. "They sold an asset in the Fayetteville that wasn't growing and replaced it with a capital program in an oily play (the Eagle Ford) that is growing. That's subtle but important, and I think it differentiates the company."

A larger oil-play stock Heikkinen likes is Occidental Petroleum Corp., despite turmoil in some of its investment areas.

"I think the market is punishing Oxy for its Middle East and North Africa (MENA) exposure," he says. Operations in the currently negatively viewed region make up about 15% of the company's cash flow and about the same percentage of Heikkinen's asset valuation.

"We have around a $120 valuation on the stock, and MENA is about $15 a share. So you have a stock now trading at a 10% discount washing out all of that business. But I don't think you are going to have the same issues in the United Arab Emirates, Qatar, and Oman that you are seeing in Bahrain and Libya. From a value-add standpoint, Qatar and Oman are more important."

Regardless, the analyst thinks Oxy's domestic operations hold the upside.

"I think California is going to be a bigger production region for Oxy than the Permian in two years."

The Permian Basin is producing about 190,000 barrels a day at present, and California yields about 135,000, he notes. Despite the difference and the current mini-boom in the Permian, Heikkinen is more bullish on California.

"The Permian is going to grow, but California is going to grow very quickly. That's the opportunity."

Between exploration and unconventional development, including the Monterey, Heikkinen sees California production increasing substantially, with Oxy a factor.

Undervalued, underloved

Michael Bodino, managing director and head of energy research, Global Hunter Securities LLC, looks for mismatched market pricing. Among his picks: Goodrich Petroleum Corp. and Carrizo Oil & Gas Inc.

Michael Bodino, managing director and head of energy research for Global Hunter Securities LLC, says his firm is looking for companies with assets that may be undervalued in the current market.

"We are looking for discrepancies in valuations where there are some understated asset values, where we see a closing of the gap between stock price and valuations. I'm looking for mismatched market pricing where you can buy something undervalued on a gas basis, but near term, the valuation driver for the stock is crude oil."

Integral to the firm's assessment was the revision of its long-term oil price deck to $90 per barrel from $80 in January. Its long-term gas clearing price is $5.50.

"Part of our rationale for that was based on fourth-quarter demand numbers being higher than expected, and a continued erosion of excess capacity," says Bodino. A mix of the right oil and gas assets is thematic of companies he is watching for this year and beyond.

Examples are Goodrich Petroleum Corp. and Carrizo Oil & Gas Inc. Both have a liquids position for now, as oil prices remain solid, and natural gas assets for later, when prices recover.

"One of my favorite picks at the end of last year was Goodrich," says Bodino, who expects it to move up further in 2011. Though the stock traded down on third-quarter 2010 earnings, it has recovered on a transition into the oily Eagle Ford.

"We very easily got to a $30 target on it, and I think it is going to be a big performer in the back half of this year because of that continued growth in oil volumes."

While short-term oil production is the story for both Goodrich and Carrizo, Bodino thinks their combination of oil and gas assets is compelling.

"Into 2012, there's the big oil story, but in the long term you have the gas story. Those are mixes of assets that get me excited."

Six months ago Bodino looked hard at Carrizo and put a $45 target on the stock—well above the rest of the Street's targets for the company at the time. He still maintains that price. And though he likes the asset portfolio, he thinks the company could beat his target with successful development in its oil plays.

"There's a lot of upside on that $45 number, predicated on converting their acreage in the Niobrara and Eagle Ford to production, as well as the North Sea coming on line in the first quarter of next year. Six times next year's EBITDA could get you to $70 to $80 a share, but they must execute and get some visibility on growth beyond this year to get to numbers like that."

Energy Partners Ltd. is an example of an underfollowed name Bodino finds interesting. The exclusively shallow water-focused E&P found itself in a dicey position for a time. It has since reorganized, paid off some debt and lowered its costs. It is now buying assets and drilling, and has assembled a big oil position.

David Kistler, director of exploration and production research at Simmons & Co. International Inc., says it's not generally understood how oily SandRidge Energy Inc. has become.

"They have good FCF (free cash flow) yield, and the strategy Gary Hanna (chief executive officer) has put in place is starting to pay off. The Anglo-Suisse acquisition is almost all oil."

Even so, the stock is trading at low multiples. Bodino says similar companies have traded at higher multiples, and EPL is still undervalued.

"A year from now, if it's still trading at three times forward EBITDA, the stock should be at $24, not $15. I can live with that," he says.

"Their reserves base is not deteriorating much, and if they have no acquisitions by the end of the year, they will have $150 million in cash, which I believe they will probably put into an accretive bolt-on."

Bodino credits the company's initiative to enhance inventory and retire debt for the turnaround. EPL stands up favorably on financial metrics, while having the ability to take advantage of deeper targets on the shelf using new technology.

"Companies are looking at new seismic-processing algorithms with great clarity to 40,000 feet. No one was drilling these fields deeper into source rock. There's more prospecting going on, and I believe it may be because of Macondo." Bodino suspects the lack of deepwater opportunities may lead companies to put more of their budget into deeper drilling on the shelf.

Laggards

David Kistler, director of exploration and production research at Simmons & Co. International Inc., is also finding value in the shift from natural gas to oil.

"If you think natural gas is fully valued in the near to medium term, then you are looking at oil-levered names. However, those names have been some of the best performers over the past two years. As such, I find myself looking for companies that are laggards, or are misunderstood as they evolve from gas-levered to oil-levered," says Kistler, co-head of E&P research.

He points to Oklahoma City-based Sand­Ridge Energy Inc., which he says underperformed in 2009 and 2010. But the company's acquisition of Forest Oil's and Arena Resources' Permian assets, and its internal development of the Mississippi Lime horizontal play, put it in a structurally more positive place for 2011.

"Some people don't understand how oily it has become. As such, it trades at a discount to my universe on upside to NAV (net asset value)," says Kistler.

"They are predominantly oil-weighted at this point and will be driving 16% production growth by applying capital to the oil side of their portfolio. We estimate an increase of over 50% oil production growth." He calculates the company's upside based on net asset value at some 50%, relative to 20% for the rest of the group he covers.

Kistler says the company's recently announced royalty trust will help fund its drilling program while it relies largely on cash from operations and previously disclosed asset sales for the balance. Still, a small shortfall will remain.

"The royalty trust will help bridge their cash-flow deficit, but even after divestitures and incorporating the trust, they will still have a $150-million gap between capex and discretionary cash flow."

As a solution, Kistler thinks the company will have ample opportunity to launch another royalty trust or pursue a joint venture similar to the recently announced Anadarko Petroleum Corp.-Korea National Oil Corp. agreement targeting the former's Eagle Ford acreage. Additionally, a JV could materially increase upside to SandRidge's NAV via accelerated development. Further, the company's borrowing base is likely to increase due to its significant oil-reserve additions.

Another favorite is Newfield Exploration Co. "Newfield is a best-in-class name," says Kistler. "It trades at a discount on multiples and NAV, and has strong return on capital employed. The company is very well hedged and has significant upside in the Eagle Ford and Granite Wash, and its Alberta Bakken asset is in the early phase of drilling." Kistler thinks results for the Bakken operations should start coming in around June. He also thinks the company's recent Monument Butte acquisition in Utah is very accretive based on the value of its previously held assets there.

"If we evaluate the Monument Butte assets on an acreage basis, based on Simmons' development estimates, it would ascribe a value of $15,000 per acre. Recently, they were able to purchase an additional 70,000 net acres at $4,400 per acre, which is extremely accretive." Depending on development, that acreage could add $3 to $5 a share to NAV.

"What was 31% upside NAV is now 40% upside versus the group, at 20%. They trade at 7.6 times enterprise value (EV) to debt-adjusted cash flow, versus 8.4 times for the group."

Kistler notes Newfield was conservative in booking reserves, writing down some of its natural gas assets as a result of its focus on highest-return projects, under the assumption that they might not be developed during the next five years. That's a move he thinks will pay off when gas prices come back, because the gas was held by production and can be developed and booked later.

Newfield is also committed to drilling from within cash flow.

"With respect to reserves, they have been extremely conservative, using only 75% of discretionary cash flow to develop their assets. If they wanted to use 100%, they could have booked a significantly larger amount. I look at them as an underperformer so far that should outperform in the second half."

Kistler thinks Apache Corp. is a deep-value pick. Compared to its peers, the company's stock is trading at discounts on multiples, specifically EV to debt-adjusted cash flow.

"Apache trades at 5.6 times EV to debt-adjusted cash flow for 2011 versus a group at 8.4 times, and it trades at 35% upside to our NAV."

For 2012, it trades at 4.9 times EV to debt-adjusted cash flow versus his group of comparables that trades at 6.7 times the same ratio. Kistler calculates the company is generating a 14% return on capital employed, increasing from 13% last year and growing to 15% in 2012. The acquisition of BP's Permian assets and exposure to the Horn River and Granite Wash plays give Apache material upside versus its peer group.

"Typically, people have looked at Apache as a diversified company but haven't had great visibility on how they will develop their assets. The Permian, Horn River and Granite Wash are three very predictable assets with long-term visibility on development. That should offer some pretty good assurance to analysts on what their NAV looks like, and ultimately drive their multiples higher."

Kistler thinks investors should pay particular attention to other activity in the Horn River.

"We'd be foolish to overlook what's happening with companies like Encana and PetroChina doing a JV in the Montney. That sets the stage for Apache, in time, to participate in a JV or export gas out of North America."

The analyst thinks Encana's participation in the proposed Kitimat liquefied natural gas project confirms natural gas' shift to a global market and is a material catalyst for Apache's growth. The company is deeply discounted now and, in his view, has underperformed year-to-date.

"Apache is positioned attractively and should outperform."

Atypical non-op

Northern Oil & Gas Inc. is a non-operating Bakken-focused company that Joel Musante, senior analyst at C.K. Cooper & Co., finds interesting. Non-operators are usually subject to the whim of their operating partners, which can make them less than ideal as an investment. Not so with Northern, says Musante.

Northern Oil & Gas Inc. is a non-operating Bakken-focused company that Joel Musante, senior analyst at C.K. Cooper & Co., finds interesting.

"When I look at the assets and the strategy, it still makes a lot of sense." He has placed a price target of $40 on the stock.

"Initially they got into the Bakken early and acquired a relatively large position, for a small company. They are in very attractive areas, so the activity came to them," he says. Because they own small working interests in many leases, the company participated in many wells and increased production quickly. As activity expanded, Northern provided an opportunity for small acreage holders to sell out small positions in new wells that were being drilled.

"They are buying quality acreage because they are buying the stuff that is getting drilled right away, and they don't have to worry about lease expirations on many of the new leases."

The company's bigger land position means more drilling locations. Northern's strategy allows it to grow acreage and production simultaneously.

"I don't know anyone who has been that successful in the past with a non-operator business model," says Musante, "because you don't know when your acreage will get drilled." Operating gives a company control of timetables and more predictable cash flows. Generally that means non-operators in less economic plays must wait for their positions to be drilled. But the Bakken is hot, and Northern has high-quality acreage there.

"Based on the latest statistics, there are 170 rigs operating in the Bakken drilling wells, and Northern participates in 141 of those," says Musante. The Street likes the Bakken's oily production mix and good-quality, economic wells.

"Northern buys acreage for $1,000 to $2,000 an acre, and the implied value is much higher," says Musante.

Analysts look for stock-price increases for these oiled-up names.