CNX Gas Corporation: A Low Cost Producer with Growing Reserves

Includes: CNX, CSD, CXG
by: Andrew Corn

An interesting constituent in the Clear Spin-Off index licensed for the Claymore/Clear Spin-Off ETF (NYSEARCA:CSD) is the Pennsylvania natural gas company, CNX Gas Corporation (CXG). Operating primarily out of the Appalachian Basin, the firm explores, develops and produces natural gas in the form of coal bed methane. Originally created in order to extract this form of natural gas for CONSOL Energy Inc. (NYSE:CNX), the firm was spun off at the end of June 2005. As an independent company, it has amassed a market capitalization of $4.35 billion and has established itself as one of the leading providers of coal bed methane.

Although the split from CNX is only partial, as it retains 81.5% ownership of the firm, CXG has acquired subsidiaries as well as rights to conduct gas production operations with its parent company's coal mining business. The company has the development rights to 4.5 billion tons of proved coal reserves, as well as 399,000 of conventional development acreage through its joint ventures.

The conventional joint acreage is 99% undeveloped, and contains over 6,000 potential drilling locations. While mining this, CXG is also constantly increasing its independent reserve, adding 11.9% in total reserves by the end of 2006 as compared to its total reserve in 2005, thereby essentially increasing its asset base.

Although CXG operates in a sector with strong competition that includes diverse firms such as Quicksilver Resources Inc. (NYSE:KWK), Ultra Petroleum Corp. (UPL), Range Resources Corp. (NYSE:RRC), and Southwestern Energy Co. (NYSE:SWN), its business model is somewhat unique.

Typically, these companies drill at depths that range from 2,000 to 15,000 feet, risking time and capital resources in search of gas. CXG, however, operates through coal seams, at depths of fewer than 2,500 feet. This eliminates some of the risk for the company, as it mines in more defined formations. It also has allowed the firm to remain one of the lowest cost producers. The trailing twelve month gross margin of 64.58% relative to the industry average of 52.30% is an example of this.

An analysis of its fundamentals reveals sound financial standing and the results of its business strategy. The firm has a one year operating margin of 49.68%, which is significantly higher than its peer group average of 6.48%. With this performance, the company has earned a one year return on equity [ROE] of 20.50%. Meanwhile, its year over year quarterly revenue growth of -46.00% will undoubtedly turn investors off. However, if we look a little deeper, we can see that the quarter actually provided the company with a net income increase of 17% over the previous year, stemming from a 16% increase in production.

As for valuation, CNX may have a price to book (P/B) ratio of 5.07 relative to an industry average of 2.79, but its growth potential may still outweigh this. The firm has a price to earnings to growth [PEG] ratio of 1.32, a figure that is not too distant from the industry average. Also impacting valuation is that there are no large Wall Street analysts following the stock, since if there were it might give its P/E and trading volume a boost. Ultimately, as a low cost producer with growing reserves and these fundamentals, we believe that CXG is an interesting stock to watch.

CXG vs CNX 1-yr chart
CNX vs CXG 1-yr chart

Disclosure: CNX Gas Corporation [CXG], is a constituent in the Clear Spin-Off index licensed for the Claymore/Clear Spin-Off ETF [AMEX:CSD]. Mr. Corn is CEO of Clear Indexes LLC which publishes the index and he owns shares of the ETF: CSD. He does not directly own shares in CXG.

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