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Jefferies' four best energy stocks for 2011

U.S. investment bank Jefferies selected four energy stocks in its 2011 Top Picks List. The average energy stock in the S&P 500 Index has gained 3.9 per cent this year, beating the broader index. With oil poised to break through $100 (U.S.) a barrel in 2011, energy stocks will likely continue to perform well. Here's a look at Jefferies' four top energy stock picks.

4. Oklahoma-based Devon Energy is an analyst favourite, receiving 21 "buy" ratings and nine "hold" calls, but no "sell" rankings.

Devon explores for and produces natural gas and oil . Its stock has run up 33 per cent in the past three months, fulfilling Jefferies' thesis. Now, it has just 3 per cent of upside before passing the bank's price target. It might be best to wait for a pullback before buying Devon. But, most-bullish Macquarie, an Australian investment bank with a focus on energy companies, expects Devon's stock to advance another 14 per cent to $98 (U.S.) in 12 months.

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Devon's business is largely focused on natural gas, with two-thirds of sales from that commodity and the other third coming from oil and natural gas liquids. It also owns gas pipelines and treatment facilities.

Natural gas is domestically abundant. In fact, some geologists estimate that North America houses the richest natural gas deposits. For this reason, businessmen, such as T. Boone Pickens, think using this resource is critical to energy independence.

The downside is that recent shale discoveries have expanded supply and dampened the commodity's pricing. Devon has been repositioning itself as an onshore North America gas company. Consequently, it has been divesting international assets and using the proceeds to lessen its float. In the third quarter, shares outstanding dropped 3 per cent to 432 million.

3. Ensco sells offshore contract drilling services to other oil and gas companies. The company is based in London.

Ensco is scheduled to report fourth-quarter results on Feb. 24. Its third-quarter adjusted earnings of 92 cents exceeded Wall Street's consensus forecast by 3.5 per cent. Revenue of $428-million beat the target by 2.1 per cent. Nevertheless, net sales are down 10 per cent over 12 months and GAAP profit has declined year-over-year in seven consecutive quarters, hurting its stock.

But, the stock is cheap relative to those of peers, trading at a trailing earnings multiple of 13, a forward earnings multiple of 13, a book value multiple of 1.3 and a cash flow multiple of 9.1, 80 per cent, 38 per cent, 56 per cent and 46 per cent discounts to oil-and-gas industry averages.

Currently, 56 per cent of analysts covering Ensco rate its stock "buy." Jefferies has a price target of $64 on the stock, suggesting 20 per cent of upside in 2011. The highest target comes from FBR Capital Markets, which predicts a rise to $70 in the next 12 months.

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2. Superior Energy Services is a specialized oilfield-services and equipment company.

This energy subgroup has been on fire in recent weeks, with recognizable names such as Halliburton and Schlumberger up 24 per cent and 26 per cent, respectively, in just three months.

Superior is attractive because it trades at a discount to its peer group and its business is at the onset of an upswing. The stock commands a forward P/E of 15, a book value multiple of 2.1, a sales multiple of 1.8 and a cash flow multiple of 6.1, 27 per cent, 26 per cent, 38 per cent and 64 per cent discounts to oil-and-gas equipment and services peer averages. Superior's sales are down 11 per cent over 12 months, but rebounded 13 per cent in the third quarter as did its earnings, up 35 per cent, exceeding consensus by 8 per cent.

Superior receives generally favorable reviews from analysts, with 10 "buy" calls, five "hold" ratings and one "sell" recommendation. In the bull camp with Jefferies is Barclays, which also projects a $43 price target for the stock, suggesting a one-year gain of 25 per cent. Superior has advanced 25 per cent in the past three months, but it is still reasonably valued relative to peers.

1. Jefferies' 2011 energy pick with the greatest upside potential is Frontline , an owner and operator of tankers that are used to transport oil, coal and iron ore. Frontline has a market value of only $2-billion, so it's a small-cap and not particularly popular.

The company's sales have dropped 9 per cent in 12 months, but its net income has increased 18 per cent. In the third quarter, Frontline swung to a profit of $13-million, or 16 cents a share, from a loss of $5.6-million, or seven cents, in the year-earlier period. Its sales grew 7.8 per cent. Like Jefferies' other energy picks, Frontline trades at a peer discount, costing 11-times trailing earnings, 14-times forward earnings and 6.2-times cash flow. The multiples represent discounts of 42 per cent, 38 per cent and 32 per cent to peer averages. The stock offers a dividend.

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Quarterly distributions vary widely. The quarterly payout has been as high as $3 a share in 2008, equivalent to 6 per cent of the stock price when paid. In the latest quarter, the dividend fell from 75 cents to 25 cents. If the 25 cent payout is maintained, then the stock will yield 4 per cent in the next year. On Tuesday, Deutsche Bank upgraded Frontline to "buy" with a $32 12-month target, suggesting 27 per cent of upside. Jefferies' $35 target suggests 39 per cent upside. Other analysts dissent. Just six rate Frontline's stock "buy" while eight rate it "hold" and 12 rank it "sell."

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