Lehman makes picks, pans in energy and power

By Ronda Fears

Nashville, Tenn., Sept. 24 - Following Lehman Brothers' recent energy conference, the convertible research team came up with a list of recommendations for convertibles to suit varying risk/reward tolerance levels.

From 25 presenters with $19.9 billion in 44 outstanding convertible issues, the analysts ended up with nine buy recommendations, two swap candidates and two sell recommendations.

"While our convertible picks were made within the constraints of these five investment categories, all selections were made in the context of the equity and credit fundamentals of the issuers," said analysts Venu Krishna, Brendan Lynch and Jocelyn Picl in the report.

The five business aspects of energy and power examined were exploration and production, oil service and drilling, energy merchant, utility and refining.

"Also, we did not feel compelled to make our picks from each investment category," the analysts said.

"In other words, if an investment category failed to produce attractive opportunities, no picks were made from that category."

There also could be more new issues emerge from the energy and power sector.

"Lehman expects $6-$7 billion of equity issuance this fall, and based on new rating agency metrics, the market could see $30 billion of equity issuance from the sector down the road," analysts noted in the report.

"Given this increased need for equity capital, we expect more companies to access the convertible market via the high equity-content mandatory structure."

Convertible picks were Pogo Producing 5.5% due 2006, Cooper Cameron 1.75% due 2021, Weatherford 5% preferred, BJ Services 0.395% due 2022, Devon Energy 0% due 2020, Transocean 0% due 2020, Anadarko 0% due 2020, TXU Corp. 8.75% mandatory and Key Energy 5% due 2004.

Swap recommendations were made into the Kerr-McGee 5.25% due 2010 and Nabors 0% due 2021.

Sell recommendations were for the Diamond Offshore 0% due 2020 and Weatherford 0% due 2020.

The starting point for the selections was with Lehman's position on the stocks in each sub-sector.

From E&P presenters at the conference, equity analysts Tom Driscoll and Jeffrey Robertson said there was an almost universally positive view of natural gas fundamentals from the supply side due to recent production decline rates.

From oil service presenters, equity analysts Jim Crandell and Angie Sedita noted the Gulf of Mexico is still soft as day rates are trending lower, pushing recovery out somewhat beyond original expectations. Thus, the analysts believe earnings could be at risk for some drillers but see it as a short-term phenomenon with drilling levels more robust late this year and into 2003.

From energy merchants, equity analyst Rick Gross said he sees regulatory and legal issues reconciliation likely within six months and the fate of merchant operations to be determined for most companies by year end. Although closer to an inflection point, his continues to recommend an underweight stance pending additional clarity.

From utility presenters, equity analyst Dan Ford noted ratings agencies are continuing to pressure companies to fix balance sheets with equity issuance and Lehman continues to expect a tough third quarter. A hot summer weather hurt gas and power trading volume, raising a cautious stance on those with trading arms like Duke Energy. Scaling back on building plans, such as Mirant's recent cancellation of a 30%-complete plant, could be a positive long term if more companies follow suit.

From refiners, equity analyst Paul Cheng said the short-to-medium term outlook remains bleak with 2003 trending up from 2002 but not enough to warrant excitement due to current weak worldwide economies and a high war premium. Next year could mark another relatively disappointing year, with margins continuing to average substantially below historical normal levels.

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