Five Natural Gas Picks with Significant Upside Potential

Just under four years ago, natural gas prices in the United States traded around $10 per futures contract. Just a few months ago, the price had plummeted to right around $2. There has been a slight recovery to above $3, but prices are still considered severely depressed from a historical context [for more natural gas news and analysis subscribe to our free newsletter].

The domestic shale gas boom shows few signs of letting up and could have created a century of supply for the U.S., according to some of the rosier industry estimates. This could easily keep prices hovering around record lows, but there is the potential to start building up export capabilities. These are subject to individual government approval, but could prove a real impetus to get prices closer to global averages. A couple of cold winters could also shift the demand and supply more into balance, as could the potential for consumer vehicles being fitted to run off natural gas instead of gasoline. Below are five natural gas firms that can benefit handsomely with a sustained rally in prices or boost in demand, be it from domestic or international sources.

Range Resources (RRC)

Range Resources is based in Fort Worth, Texas and focuses on exploration & production (E&P) activities for natural gas and oil properties. Its main areas of focus include the Appalachian and Southwest regions. Growth has been robust at Range over the past five years. Over this period, it has nearly tripled its proved reserves and more than doubled production [see also 25 Ways To Invest In Natural Gas].

As has become commonplace in the industry, production growth should continue but it will be far less profitable given the plummet in natural gas prices. For the year, analysts project sales growth of close to 15% for Range, total sales of $1.4 billion, but a nearly 40% drop in profits to $0.70 per share. This is a far cry from the $2.20 in earnings it reported in 2008. The valuation looks stratospheric on a P/E basis, which is currently around $100, but the company has substantial value based on its production assets. The stock could eventually recover closer to $80 per share, which is a level it traded at around a year ago and nearly 30% ahead of current levels.

Chesapeake Energy (CHK)

Chesapeake Energy is in a similar position as Range Resources in terms of its recent profit plummet. Sales are also projected to take a tumble of nearly 25% for the full year. Analysts project earnings of only $0.35 per share and sales below $9 billion. However, and again in casino online similar fashion to Range, Chesapeake’s asset value is substantial. This was evident in its second quarter earnings report [see also Natural Gas, UNG On a 70% Rally].

The company said it expects to sell $11.7 billion in assets by the end of the third quarter to shore what was to be shortfall in spending based on its lower cash flow generation for the year. Several months ago, CEO Aubrey McClendon suggested a total asset base worth as much as $60 billion. With a current market capitalization of only around $12 billion, this implies significant potential share price upside.

EnCana (ECA)

Prior to the plummet in natural gas prices, in 2009 Canadian gas giant EnCana reported $2.48 in earnings per share. The prior year it reported close to $6 in EPS. Suggesting EnCana returns to these former profit peaks is unlikely in the near term, but does illustrate its ability to generate significant returns for shareholders in a more normal pricing environment. It is currently shifting to natural gas liquids from dry natural gas that is most commonly quoted in the marketplace.

A move more toward oil could also help in the near term. Longer-term, this is again an asset play. Stated book value was recently around $22 per share, or right at the current stock price. This clearly underestimates the market value of its production assets, but could indicate a floor on the stock. Analysts project a full year sales decline of 33% to below $6 billion and profits under $1 per share, but there is again recovery potential on most operating fronts [see also Five ETFs to Ride the Natural Gas Rally].

Devon Energy (DVN)

Devon Energy has many similar attributes to archrival Chesapeake. Its sales for the year should also come in around $9 billion and it has staked its future on domestic natural gas production, having sold off many of its international assets recently. However, this has put it in a much stronger financial position and its current market capitalization is close to double Chesapeake at $23 billion. Profits are holding up much better. Analysts project profits of $3.61 per share for all of 2012. This is still significantly depressed from closer to $10 just a few years ago. A return closer to these levels suggests potential share price upside of more than 30%.

Anadarko Petroleum (APC)

Anadarko Petroleum counts on domestic natural gas for around half of its production. This is substantial, but that means that the other half stems from other sources, such as offshore drilling. As such, the firm represents a way for investors to gain exposure to a potential recovery in gas pricing, but also a slight hedge should prices remain depressed. Oil prices have also come down in sympathy with concerns for flagging global growth prospects, but have still held up much better in comparison to natural gas [see also Want Juicy Dividend Yields? Buy the Top Five Commodity Megacaps].

Analysts project only a slight 3% decline in sales for all of 2012 to below $14 billion. However, profits should remain somewhat steady at $3.47 per share. This is still down significantly from more than $8 several years ago, but again speaks to the profit recovery potential if and once natural gas pricing rebounds.

Natural Gas in Recovery?

Timing the ups and downs in commodity prices is fraught with peril and uncertainty. One saying in the investment industry is that the only individuals able to time market peaks and valleys with any certainty are liars, meaning predicting the future over short-term periods is close to impossible. However, a contrarian stance can make sense. In the natural gas space, it probably pays to be nibbling on the market leaders, such as those firms listed above. Individual firm dynamics will also be at play, but in general natural gas prices should tick upward at some point going forward [see also The Ten Commandments of Commodity Investing].

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Disclosure: No positions at time of writing.

About Ryan Fuhrmann

Ryan Fuhrmann, CFA, is a freelance financial writer and investor. He settled on a pursuit of investing after taking a class entitled "Security Analysis" while at the University of Wisconsin-Madison and has since adopted a value-based philosophy toward the markets. His work and interviews have been quoted in the press and investment publications including "Barron's" and local business journals. Ryan is also an advisor to Butler University's student managed investment portfolio and co-hosts the Smart Money Show on Saturday mornings on Freedom 95.9 WFDM in Indianapolis.
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  • commoad

    I went long, BOIL. A leveraged NG play.