Susan Byrne, who started buying energy producers for her Gabelli Westwood Equity Fund in 2003, said she's staying with the stocks because...
Susan Byrne, who started buying energy producers for her Gabelli Westwood Equity Fund in 2003, said she’s staying with the stocks because they would still be cheap even if oil falls by 50 percent from its recent highs.
“People are obsessed about what will happen with the price of oil, and whether you should sell the stocks or hold them,” Byrne said from her office at Westwood Holdings Group in Dallas. “These stocks have little downside risk.”
Byrne has 18 percent of her fund’s assets in oil and gas companies, including ConocoPhillips and Burlington Resources.
That proportion exceeds the group’s 10 percent weighting in the Standard & Poor’s 500 index.
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The $183 million Westwood fund rose at an annual rate of 2.9 percent in the past five years, ranking in the top fifth of 227 funds tracked by Bloomberg that invest in so-called growth stocks. The S&P 500 dropped an average 2.2 percent a year in the period.
Byrne’s fund was up 10.8 percent in 2005, as of Sept. 7, trailing the 16 percent advance of top-performer Bridgeway Aggressive Investors 2 Fund.
Starting her career in the 1970s, when oil-price shocks led to soaring inflation, recession and a stagnant stock market, taught Byrne to consider risks before returns, she said. She develops worst-case scenarios for stocks and buys those she sees as undervalued and therefore cushioned from declines.
With help from 12 analysts, Byrne scans for shares that have a risk-reward ratio of 1-to-3, measured by the “worst-case” level compared to her target price based on free cash flow and earnings. She focuses on free cash flow, or profit from operations minus capital expenditures, because that’s what supports the company’s ability to grow, Byrne said.
She estimated that less than 50 percent of the stocks they look at meet the risk-reward standard.
“We never start with what’s the best outcome because the best outcome will take care of itself,” Byrne said. “Our first thought is about the downside risk.”
Shares of ConocoPhillips, the No. 3 U.S. oil company, have doubled since 2003 and shares of Burlington Resources have more than doubled. Both companies are based in Houston.
With the market rally, Byrne’s team has re-evaluated those investments, analyzing what cash flow and earnings would be next year with oil prices at $32.50, $45 and $55 a barrel and natural gas in an equally wide range.
Byrne said her energy holdings would trade for about six times 2006 cash flow if crude prices average $32.50 a barrel next year and natural gas averages $4 per million British thermal units.
That’s in the middle of the 4 to 10 times range of the past 30 years, Byrne said.
If the average oil price exceeds $55 a barrel next year and natural gas is more than $7 per million British thermal units, well below current levels of $66 crude and $11 natural gas, then the stocks sell at four times cash flow, which is “ridiculously cheap,” she said.
Money manager George Schwartz disagrees.
“My view is the price of these stocks is going to come down with the price of oil, even though the earnings will still be good,” said Schwartz, who manages $650 million at Schwartz Investment Counsel in Bloomfield Hills, Michigan. “The psychology will shift that the run is over.”
All of Byrne’s personal money is invested at Westwood, which now manages $4 billion. Despite her stock-picking success, Byrne says she tries not to let it go to her head.
“They have a saying that the whale that spouts the highest is the first to get harpooned,” she said. “When you allow any hint of smarty-pants to come into your work, you’re cruising for a bruising.”