Bottom Fishing For A Natural Gas Investment

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 |  Includes: CPK, NFG, NGL, NJR, OKE, SJI, SR, SWX
by: James Shell

I've been asked by one of my followers to take a look at an investment in the natural gas industry right now.

Here is the logic: The right time to get into an industry is when it is completely beaten down, and a good strategy is to select the companies that are doing well even when times are tough. Then, when the industry comes back, you can maximize your proverbial shareholder value.

Here is some background:

The natural gas price was strong in 2008, the price was about $13 per bcf that year. Since then, the price collapsed, it is now about $2 per bcf, and this happened for two reasons: The overall economic downturn, and also new production: New sources of gas in North America have been opened up because of various new technologies in shale deposits that are being drilled because of the simultaneous high price for crude oil.

Add to that a mild winter in North America, which has caused a further decline since January.

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So, we're in a period right now of an unusually oversold natural gas market.

In all commodities, the seeds of the next price spike are sown during periods of oversupply, and in the case of natural gas, there are two things going on: The EPA has, for the first time, set limits on greenhouse gases from power plants in such a way that new construction will be almost certainly natural-gas-fired. Also, the high cost of heating oil is causing the conversion of a lot of residential and industrial customers to natural gas. So it is pretty easy to envision a time when the economy and pricing recovers, the nation is locked into natural gas, and the price will at the very least return to a more reasonable level.

I've selected a little population of companies in the natural gas business as follows:

Company Symbol Price Mkt Cap EPS Growth Div Yld PE
NEW JERSEY RESOURCES CORP NJR $45.44 $1.9B 134% 3.37% 15.7
ONEOK INC. OKE $81.71 $8.5B 42.11% 2.99% 19.4
SOUTH JERSEY INDUSTRIES INC. SJI $50.60 $1.5B 41.86% 3.18% 15.2
SOUTHWEST GAS CORP SWX $43.42 $2.0B 21.43% 2.72% 15.4
CHESAPEAKE UTILITIES CORP. CPK $41.43 $398.9M 12.16% 3.31% 13.4
LACLEDE GROUP INC. (THE) LG $39.70 $891.1M 6.67% 4.19% 14
NATIONAL FUEL GAS CO NFG $48.33 $4.0B 4.29% 2.96% 17.1
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These were selected on the basis of the fact that even in the face of this decline in the price of the underlying resource, they have all shown year-on-year EPS growth. Most of them are paying reasonable dividends, and in many cases, the stocks are cheap, in light of the seasonality. Here is the six-month price chart:

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Most of these stocks are down anywhere from 10 to 15% since January.

I've done a little digging through the investor presentations and come up with the following:

New Jersey Resources , South Jersey Industries , and Chesapeake Utilities: I've grouped these three together because they are all in the business of natural gas distribution in the Mid-Atlantic area, which is still the number one area in the country for residential heating oil usage. Therefore these three are all beneficiaries of the trend toward higher natural gas usage in this region, and thus have the highest rate of growth. Of the three, SJI is the most beaten down since January, but CPK is the cheapest based on its projected earnings next year. Of the three, SJI is the least favored by the analysts with an average rating, per Yahoo Finance, of 1.6 out of 5, NJR is a little more than 3, and CPK in between at 2.3, but remember, we are bottom fishing, and we might be tempted to take the opposite view.

Oneok : I happen to like what this company is doing. Oneok is an integrated natural gas provider which is capturing natural gas liquids ((NYSE:NGL)) from the various oil deposits in the Oklahoma/Kansas/Texas region, as well as the Bakken in North Dakota, and distributing it in the form of natural gas to pipelines and customers in the middle of the country. About 60% of their revenues are what they call "non-discretionary and fee based", which is a polite way of saying that they have a lot of captive customers depending on them and only them to keep running. The company has announced a 2 for 1 stock split which will occur at the end of May, the stock price is a bit beaten down from earlier in the year, and the company has an active capital expansion program underway. There is one question: what will the dividend be after the split? The PE is the highest of this little group, which may be an artifact of investors wanting to capture some value during the split.

Southwest Gas : This company operates natural gas distribution in the Nevada/Arizona/Western California area, a part of the country not known for its heating oil demand, but well known for its electricity demand. The company has experienced growth this year mainly because the depressed economy in the region has improved a bit. This company has a history of dividend increases, and 50% of Nevada's electrical power is now generated by coal, so there are some prospects to eventually convert some of this over.

Laclede Group : This company is operating a pipeline and distribution network originating mainly in Oklahoma, and distributing gas to customers in the St. Louis area. They are benefiting from the availability of low cost supplies from shale gas in that region. According to their most recent investor presentation, the company is targeting non-regulated and therefore price-friendly business, as well as natural gas fired power generation. The company has already announced a 4 cent per share dividend increase for the 2012 fiscal year, dividends have increased every year for the last five, the dividend yield is already the highest in this group, and so that might be the compelling reason to like the stock.

National Fuel Gas : This company is involved in transporting natural gas from the pipeline system as well as some of the shale deposits in Western Pennsylvania and marketing it in the Buffalo NY area. The company has still managed positive EPS growth in the backyard of the coal industry, and selling into a low-economic-growth market. The company is also doing some exploration and production in the Marcellus Shale area of Pennsylvania, also in California, but some of their rigs in the Marcellus are shut down because of the current low price for gas, and they anticipate further rig curtailment in 2013.

The risks? I suppose like in all bottom fishing expeditions, there is the possibility that things could get even worse in this industry, or there could be more general economic chaos. The argument can be made that in each of these cases there is more opportunity on the upside at least for the time being.

The world is full of chaos, and there are no guarantees on anything. Do with this information what you will.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.