Three Undervalued Natural Gas Stocks

Our long-term investment conclusion is upbeat despite our seemingly downbeat reduction in assumed long-term price of natural gas to $8.00 a million btu from $10.00 previously. That change triggers a reduction of 20% in our estimate of Present Value of North American Natural Gas (NANG). Accordingly, McDep Ratios move up to a median of about 0.74.

Meanwhile, the closest market indication of long-term natural gas price is the average of futures quoted monthly for the next six years. Though that price has averaged $8.00 for the past three years, it has declined to $6.60 on the July 16 settlement. Yet, a median McDep Ratio of 1.0, where stocks would be fairly valued at current prices, implies a long-term price expectation of about $6.00 (8.00 times 0.74). By setting our present value calculations to $8.00, we are saying that $6.00 is too low, $6.60 is too low and that stocks are a bargain.

For immediate action we have three natural gas buy recommendations, Cimarex Energy (XEC), Dorchester Minerals, L.P. (DMLP) and Hugoton Royalty Trust (HGT).

Global Trading Indicators Support Oil and Gas Investment
Starting at the most general level, we see the U.S. dollar in a downtrend with the DXY index at about 0.79 compared to the 200-day average of about 0.84. Next, we see inflation expectations in an uptrend as measured by the difference between nominal rates and real rates. Nominal interest rates appear to be in an uptrend with interest on the U.S. Ten-Year Note at about 3.5% compared to the 200-day average of about 3.1%. The difference relative to the real yield on the Ten Year U.S. Treasury Inflation Protected Security appears to be widening. Global stock markets are in an uptrend with most major indices trading above the 200-day average. Emerging markets are leading.

A declining dollar, rising inflation and a positive stock market backdrop are good for oil price with six-year futures trading at $76 a barrel compared to the 40-week average of $71. Reasonable demand expectations combined with a tight supply outlook are also supportive of rising oil price. Natural gas verges on a rising trend.
Combining the global influences, investors see leading performance occurring in non-U.S. and oil oriented stocks and catch up potential in U.S. and natural gas oriented stocks. Given the broadening positive stock price indicators it seems just a matter of time before natural gas stocks join the uptrend.

Originally published on July 17, 2009.

Comments

[skwestorange:]

No recognition of the supply glut which more than offsets the positives cited?

Aug 10 08:35 AM

[Mad Hedge F...:]

Why not UNG? I have been a growling, obnoxious, and highly unpopular bear on natural gas since I put out my sell recommendation on June 2 , just before the crash from $4.30 to $3.10. Since then it has been bouncing around like a ball bearing in a boxcar on the Durango & Silverton Railway. Devon Energy’s (DVN) CEO Larry Nichols has me wondering how long this exasperating action will continue, and when a recovery will begin, if ever. NG has been a screaming chart buy for months, but with terrible fundamentals. Thanks to advanced fracting technologies, hardly a week goes by without a major new find somewhere in North America, taking our reserves from nine years to 100 years in a New York minute. So the US is sitting on a gigantic untapped gas formation? Who knew? DVN, one of the best managed companies in the industry, has a balanced oil/gas portfolio. Fortunately, windfall profits in oil have offset wrenching losses in gas. By chopping NG exploration to nothing, it has halved its drilling budget, and that money has dropped straight to the bottom line, enabling it to announce great earnings. See my call to buy competitor Chesapeake Energy (CHK) before its unbelievable 250% run . Despite the prices not seen in a decade, gas demand from industry remains moribund. But Nichols thinks continued production cuts will bring the gas market into balance sometime this winter, making those charts a lot more interesting. Maybe you should be picking up some of the NG ETF (UNG) on its next dive down to $12.50.

Aug 10 12:10 PM

[whidbey:]

Thank you. Take good care of yourself, I hope your views are catching. I have some HGT, quite a bit really, that you could have. Just let me know. I like upbeat evaluations and I hope you develop a following.

Aug 10 12:28 PM

[Steven Ward:]

Look at the recent SA article that cites majors explorers and integrateds producing higher volumes of NG just to achieve profits for the sole purpose of management bonus.

Excellent article. The only way NG perks up is if government action takes place on the cheap imports of LNG comming online, incentives for NG conversions in the Northeast, LNG exports to Europe and turning NG into gasoline and diesel. The latter might be a good use of TARP monies
Otherwise who knows when NG perks up.

Aug 10 12:40 PM

[H. T. Love:]

Long-term, I have no doubt. However, I believe you are remiss in not informing of the near-term issues and the consideration of *timing* an entry that should be included.

Without at least a mention of those two items, I can only view the article as a shill for some vested interest.

Disclosure: long UNG short calls for a *trade* only, *not* a long-term investment at this time.

HardToLove

Aug 10 08:49 PM

[Mad Hedge F...:]

kruj. I ran some numbers today and came to the staggering conclusion that at $3.60/BTU, natural gas is now cheaper than coal in some markets. One ton of high grade Pennsylvania anthracite costs $65/ton. Some 18 million BTU’s of natural gas, the energy equivalent, costs $66, and doesn’t give you black lung, asthma, lung cancer, polluted air, and mountains of ash. The BTU equivalent of crude comes in at $210, and high test gasoline at an extortionate $420. The crude/NG ratio is at 19:1, an all time high, and an entire generation of ratio traders has been wiped out. It’s just another one of those six standard deviation events which seem to be happening constantly. And like a rubbernecker driving past a gory accident where the human organs are draped over the detailing, I am always interested in wipe outs. Yes, I saw the movie Crash. Don’t ask. Why aren’t the power companies jumping in and burning gas instead of coal? There is the minor issue in that the industry needs $500 billion and ten years to build the plants to take advantage of the enormous new supply. So only frenetic production cuts will support the price until then, which are accelerating as you read this. Or a major hurricane. Better keep UNG on your screen and buy the next wash out.

Aug 10 11:51 PM

[Shale Gas:]

here's an interesting article on natural gas staying below $4 for years:

www.rigzone.com/news/a...

Aug 13 06:59 AM