These four offer growth, inflation hedge

Resource prices have climbed sharply since early 2009, as the global recession began to ease and some countries’ economies returned to growth. Despite their recent gains, prices for oil, gold and other commodities will likely keep rising. That’s partly because resources act as a hedge against inflation.

We feel the best way to profit from rising resource prices is with high-quality companies, such as these four. They are all leaders in their fields, and are doing a good job of keeping their costs down. However, only three are buys right now.

ENCANA CORP. $55 (New York symbol ECA; Conservative Growth Portfolio, Resources sector; Shares outstanding: 751.2 million; Market cap: $41.3 billion; Price-to-sales ratio: 2.1: WSSF Rating: Average) will split itself into two separate companies in December, now that shareholders have approved the plan. Break-ups like this help unlock hidden value, and generally lead to above-average results for a period of years.

One company will keep the EnCana name, and will focus on unconventional natural gas. The other will operate as Cenovus Energy Inc. (New York symbol CVE), and will specialize in oil-sands projects, oil refineries and conventional natural gas. The new EnCana will account for about two-thirds of the company’s current production and reserves. Cenovus will account for the remaining third.

EnCana will give its shareholders one new common share in each of the two new companies for every EnCana share they own. As well, investors will not have to pay capital-gains taxes until they sell their new shares.

Initially, EnCana intends that the two companies’ combined dividends will equal its current annual dividend rate of $1.60 per share, for a 2.7% yield.

Meanwhile, EnCana earned $1.03 a share in the third quarter of 2009. That’s down 46.4% from $1.92 a year earlier. Cash flow per share fell 25.9%, to $2.77 from $3.74. Lower oil and natural gas prices were the main reasons for the drop. Lower prices also prompted the company to scale back its production by about 10%, and put off investments in new projects.

Following the break-up, the new EnCana will sell some of its less-profitable operations. These include its unconventional natural-gas properties in Wyoming. The sales could generate around $1 billion for the new company. As well, Cenovus aims to raise $500 million for new oil-sands investments by selling its conventional natural-gas operations.

EnCana is a buy.

APACHE CORP. $98 (New York symbol APA; Aggressive Growth Portfolio, Resources sector; Shares outstanding: 336.2 million; Market cap: $32.9 billion; Price-to-sales ratio: 4.1: WSSF Rating: Average) produces oil and natural gas from properties in the U.S., Canada, the U.K., Australia, Egypt and Argentina.

The company gets roughly 50% of its production from oil, and 50% from natural gas. This balance has helped shield the company from falling gas prices, which are down over 50% from a year ago. Oil prices, by comparison, are down roughly 35%.

Despite the lower prices, Apache increased its daily production to a record 607,118 barrels (including oil and natural gas) in the third quarter of 2009. That’s up 3.4% from the previous quarter, and 19% from a year earlier.

The company’s offshore platforms in the Gulf of Mexico returned to normal operations after being disrupted by hurricanes in the year-earlier quarter. As well, its gas-processing facility in Australia resumed operating in the second quarter of 2009 following an explosion last year. These were the main reasons for the higher production.

Apache uses hedging contracts to lock in selling prices and cut risk. However, in the three months ended September 30, 2009, its per-share earnings still fell 50.5%, to $1.58 from $3.19 a year earlier. Cash flow per share dropped 38.9%, to $3.84 from $6.28. Revenue fell 30.7%, to $2.3 billion from $3.4 billion.

The stock has nearly doubled since March. It now trades at 18.1 times the $5.40 a share that Apache is expected to earn in 2009. It also trades at 7.9 times its likely cash flow of $12.40 a share.

These are reasonable multiples in light of Apache’s high-quality reserves and geographic diversity. As well, its plan to add 40,000 barrels to its daily production in 2010 will let it profit as energy prices improve with the global economy. The $0.60 dividend yields 0.6%.

Apache is a buy.

NEWMONT MINING CORP. $55 (New York symbol NEM; Aggressive Growth Portfolio, Resources sector; Shares outstanding: 490.2 million; Market cap: $27.0 billion; Price-to-sales ratio: 4.0; WSSF Rating: Average) is one of the world’s largest gold-mining companies. Newmont has major mines in the U.S., Canada, Australia, New Zealand, Peru and Ghana. It gets about 80% of its revenue from gold. The remaining 20% comes from copper, zinc and other metals.

Most of Newmont’s copper comes from the large Batu Hijau gold/copper mining complex in Indonesia. As part of its original 1986 deal to develop Batu Hijau, Newmont and its partners agreed to lower their stakes in the mine, in stages, by selling them to the Indonesian government. As a result, the company recently reduced its stake in Batu Hijau to 31.5% from 45%. In exchange, Newmont received roughly $669 million. The company expects to sell more of its stake in Batu Hijau over the next few months.

Meanwhile, Newmont earned $388 million in the three months ended September 30, 2009. That’s 113.2% higher than the $182 million it earned a year earlier. Per-share earnings jumped 97.5%, to $0.79 from $0.40, on more shares outstanding. Cash flow per share gained 94.8%, to $1.85 from $0.95. Revenue climbed 49.5%, to $2.05 billion from $1.4 billion. The gains were mainly caused by higher average gold prices (up 11%), and higher gold sales (up 16%). Newmont also cut its operating costs and benefited from higher copper prices and production.

The company should earn $2.33 a share this year. The stock trades at 23.6 times that estimate. That may seem high, but it’s still reasonable for a low-cost gold producer like Newmont. The $0.40 dividend yields 0.7%.

Newmont Mining is a buy.

WEYERHAEUSER CO. $39 (New York symbol WY; Conservative Growth Portfolio, Resources sector; Shares outstanding: 211.4 million; Market cap: $8.2 billion; Price-to-sales ratio: 1.4; WSSF Rating: Extra Risk) is a major North American lumber and paper producer. It owns or leases over 37 million acres of timberland in the U.S. and Canada.

Slow housing markets continue to weigh on lumber demand. In the three months ended September 30, 2009, Weyerhaeuser’s revenue fell 33.2%, to $1.4 billion from $2.1 billion a year earlier. Its losses ballooned to $56 million, or $0.26 a share, from $3 million, or $0.01 a share. These figures exclude several non-recurring items, including gains on sales of excess land and operations, writedowns and costs to close sawmills and other facilities. So far, these moves have helped cut the company’s annual expenses by $450 million.

Weyerhaeuser is still looking at converting to a real estate investment trust (REIT), which would lower its income taxes. Many of its rivals operate as REITs, and enjoy a tax advantage over the company.

If Weyerhaeuser does convert, it will have to distribute its retained earnings to its shareholders, and the IRS requires it to make at least 20% of this payout in cash. That means the company will probably wait until next year before converting, so it has time to build up its cash reserves.

Weyerhaeuser will likely lose $1.96 a share this year. But its losses should shrink to $0.69 a share in 2010. The $1.00 dividend still seems safe, and yields 2.6%.

Weyerhaeuser is a hold.