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On Jan 14, we downgraded independent oil and gas exploration and production company, Stone Energy Corporation (SGY - Analyst Report), to Underperform from Neutral. The company’s negative earnings surprise for the last three quarters, its lower price realization and spiraling operating expenses compelled us to lower our recommendation.

Why the Downgrade?

Estimates for Stone Energy – which remains engaged in the acquisition and subsequent exploration, development, operation and production of oil and gas properties located primarily in the Gulf of Mexico (GoM) – have been experiencing a downward trend ever since it reported third quarter results on November 6.

The company’s third quarter earnings per share of 50 cents missed the Zacks Consensus Estimate of 53 cents. In fact, Stone Energy has underperformed the Zacks Consensus Estimates for the last 3 quarters, delivering an average negative surprise of 11.3%.

Over the last 60 days, the Zacks Consensus Estimates for the fourth quarter and 2012 fell 11.5% and 1.8% to 54 cents and $2.71 per share, respectively. The Zacks Consensus Estimate for 2013 has also dropped 9.7% to $2.14 per share during this period.

During the last few quarters, Stone Energy’s earnings have been adversely affected by lower price realization and higher operating expenses. In particular, overall realization on a per thousand cubic feet equivalent (Mcfe) basis was down almost 8.2% year over year during the last reported quarter, while lease operating expenses increased nearly 31% from the year-ago period.

Moreover, Stone Energy’s results are heavily dependent on the growth visibility of its onshore properties as well as outcome of various deepwater exploration prospects.

Other Stocks to Consider

While we prefer to stay away from Stone Energy until we witness improvements in its performance, there are certain stocks within the oil and gas sector that are worth considering. These include Cabot Oil & Gas Corp (COG - Analyst Report), EPL Oil & Gas, Inc. and Breitburn Energy Partners L.P. (BBEP - Snapshot Report). All three have attractive prospects.

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