The Marcellus Shale in the Appalachian Basin contains extensive natural gas reserves. The Marcellus Shale covers parts of New York, Pennsylvania, Ohio, Maryland, West Virginia, and Virginia. It also covers small portions of Kentucky, and Tennessee, and runs into the southern Ontario region of Canada.
The natural gas in the Marcellus Shale is extracted using horizontal drilling and hydraulic fracturing or ‘fracking’ techniques. I’ve compiled a list of eight companies doing significant business in the Marcellus Shale.
Company | PE Ratio | PEG | EPS | Op.Cash Flow | Cash | Debt | 5 Year Expected Annual Earnings Growth |
Chesapeake (CHK) | 9.3 | 0.81 | 1.99 | $4.87B | $111M | $11.84B | 9.96% |
EOG Resources (EOG) | 21.52 | 0.36 | 3.9 | $3.96B | $1.39B | $5.23B | 75.99% |
Anadarko (APC) | 20.84 | 0.84 | -4.38 | $5.91B | $3.49B | $13.94B | 27.57% |
Penn Virginia (PVA) | N/A | -0.76 | -2.8 | $114.13M | $3.58M | $613M | 5% |
ExxonMobil (XOM) | 9.59 | 1.07 | 8.28 | $57.65B | $11.02B | $16.76B | 8.75% |
Range Resources (RRC) | 42.1 | 1.38 | -1.63 | $528.25M | $51.88M | $1.79B | 41.3% |
Exco Resources (XCO) | 11.12 | 0.65 | 0.54 | $419.26M | $56.42M | $1.71B | 21.67% |
EQT Corp. (EQT) | 20.13 | 0.97 | 3.09 | $882M | $334.9M | $2B | 25.67% |
Ultimately, the U.S. government needs to get on board with the natural gas movement. It needs to create an energy policy that will stimulate domestic usage of natural gas. Getting commercial truck and car fleets to convert to natural gas would be a key start. I think that it is just a matter of time before a natural gas energy policy is adapted. These stocks will get a big boost from such a policy, but in the meantime they should move higher based on earnings.
ExxonMobil (XOM) is included in the list because its subsidiary, XTO Energy, has a presence in the Marcellus Shale. XTO has 25 years of experience in understanding how unconventional resources can be made profitable.
Choosing ExxonMobil as an investment would be the most conservative way to play the Marcellus Shale since it is also a large oil company. XOM pays a 2.3% dividend and is a cash generating machine. Although XOM’s total annual yield in terms of dividends plus earnings growth is a market matching 11.05%, the downside risk is the lowest among these stocks.
EOG Resources (EOG) would be the most aggressive pick as its expectations for future earnings are the highest. However the stock can be volatile as we’ve seen it go from a high of $121 down to a low of $67 before recovering to its current price of $97 in the last 52-week period.
EOG just announced a quarterly dividend of 16 cents per share, which equates to a 0.70% yield. Its stock is undervalued with a PEG of only 0.36 and it trades at only 2.1 times book value per share. If it can hit its lofty earnings growth expectations of 76% per year, then EOG’s stock should be proportionally rewarded. The current stock price of $97 could hypothetically hit $1600 five years from now, creating a 16 bagger. On the other hand, if EOG has trouble meeting its expectations the stock could take a beating.
Range Resources (RRC) also has high earnings growth expectations as it is expected to grow annually at 41%. I wouldn’t consider it undervalued at current levels. However, it does look fairly valued as it trades at about 4 times book value per share.
RRC owns 1.1 million acres in the Marcellus Shale. Range Resources was actually credited with discovering the Marcellus Shale (pdf).
Range Resources currently pays a small dividend of 16 cents per share which equates to a yield of 0.30%. If it consistently meets or exceeds its earnings expectations, the stock could be over $300 in five years.
Chesapeake Energy (CHK) was originally formed with just $50,000 in capital and only 10 employees back in 1989. It has since grown to become a $14.7 billion company. It is the largest leasehold owner in the Marcellus Shale. CHK has 2.4 million acres under lease in the Marcellus Shale.
CHK is undervalued with low PE and PEG ratios. It trades at only 1.1 times book value per share.
Chesapeake pays a 1.5% dividend. When combined with its expected annual earnings growth of 9.96%, investors should enjoy a total annual yield of 11.46%.
Anadarko Petroleum (APC) has 2.4 billion barrels of oil equivalent (BBOE) as of December 31, 2010. It established 1.5 million BOE in the Marcellus and Eagleford Shales.
Anadarko is undervalued with a PEG of 0.84 and the stock trades at only 1.95 times book value per share.
APC currently pays a dividend of 36 cents per share, which equates to 0.50%. It is expected to grow earnings annually at an aggressive 27.57% for the next five years. If it hits these expectations, Anadarko’s stock could conceivably be over $240 five years from now.
EQT Corporation (EQT) is a mid-cap stock that owns 3.5 million acres, has over 14,000 productive wells and 5.2 trillion cubic feet of total natural gas reserves. It has 11,400 miles of gathering and transmission pipeline. EQT operates the infrastructure that delivers natural gas throughout the Northeast.
Its stock is undervalued as it trades at only 2.36 times book value per share.
EQT pays a dividend of 88 cents per share, which equates to 1.6%. It is expected to grow earnings annually at a healthy 25.67% for the next five years. Investors can expect a total annual yield of 27.27% if its earnings expectations are met.
Exco Resources (XCO) operated a total of 7,276 wells with proved reserves of approximately 1.5 trillion cubic feet equivalent as of December 31, 2010.
Exco is undervalued with a PE ratio of 11.12 and a PEG of 0.65. The stock trades at only 1.21 times book value per share.
Exco pays a dividend of 16 cents per share, which equates to 1.6%. It is expected to grow earnings annually at 21.67%. This creates a total annual yield of 23.67% if expectations are met.
Penn Virginia Corporation (PVA) is a small cap oil and gas company that owns 1.2 million net acres of leasehold interests and has 942 billion cubic feet of proven natural gas and oil reserves.
PVA stock dropped from $18.31 down to its current price of $4.46 in the last 52 weeks as it reported negative earnings. However, the stock is now trading 4.3 times under its book value per share, making it extremely undervalued.
PVA does pay a dividend of 23 cents per share, which equates to 5.1%. However, I would like to see a few quarters of positive earnings before I would touch this stock. It’s only expected to grow earnings annually at 5% per year for the next five years.
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Conclusion
The U.S. Energy Information Administration expects natural gas prices to average $3.70 per MMBtu in 2012. This is below the 2011 average of $4.02 per MMBtu. Natural gas prices need to be at least $3 for drilling to be profitable for most natural gas companies, so profitability will be pinched but not lost.
Since the stocks of most of these companies have already taken a hit causing an undervaluation, I think that now is a good time to enter a position for a long-term view. Eventually, an energy policy should be developed that will allow our homebred natural gas to be used in larger numbers to decrease our dependency on foreign fuels. This legislation will provide a sizable boost to the natural gas companies.
Young aggressive investors may consider EOG Resources or Range Resources as the expectations and risk are the highest, while those nearing retirement may consider ExxonMobil since it has the lowest downside risk. Those of us in the middle may consider the companies that are expected to grow earnings in the 20% - 30% range annually. These would include: APC, XCO, and EQT.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
