Now is a good time to invest in the energy industry, as commodity prices will remain high and stock valuations in some instances still appear low, according to James Elliot, portfolio manager for Elco Management Co. LLC. The New York company manages Elco Energy Fund LP, which rose 49% in 2003. Since it was established in 1995 to invest in energy and electric utility equities and fixed income securities, this fund has outperformed the composite energy indices and the Standard & Poor's 500. Elco also manages Elco Select Fund LP, a hedge fund formed in January 2002. It too invests primarily in energy-related equities. The Select Fund was up 37.7% in 2003, versus 25.65% for the Dow Jones Energy Index and 28.68% for the S&P 500. Elco's largest holdings are Anadarko Petroleum Corp. and Schlumberger. "Oil and gas companies today have never been financially healthier," says Elliot. "They have deleveraged their balance sheets and are aggressively paying down debt, initiating dividend payments and repurchasing stock. Free cash flow is no longer the exception, but increasingly, the norm." Even though oil and gas prices are strong, unlike in the past, managers are more conservative in setting their capital budgets, he notes. "Now is an excellent time to invest in energy equities," he says. "Valuations for oil and gas companies are at levels they were 10 to 15 years ago, while earnings exceeded most other industry sectors in 2003." Elliot believes several factors will continue to drive investment in energy. First, the U.S. economy is strengthening. Second, gas prices are expected to remain high as limited supply, coupled with increased demand, supports a firm price structure. Third, energy stocks historically have outperformed the market during times of rising interest rates, a phenomenon we may see in 2004. Fourth, more electric power plants and residences are using gas. Fifth, industry rotation favors the energy sector, as the high-tech and industrial stocks made big price gains in 2003. Now it is energy's turn. Finally, the energy sector accounts for only 5% of the S&P 500 Index compared with 20% in the past. Elliot says Elco favors companies with strong balance sheets, solid management and rising net free cash flow.
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