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Despite a disappointing 21.4% miss in the first quarter, Cabot Oil & Gas (COG) has gained 36.3% over the last three months. The general performance has been strong with management beating expectations by an average of 6% during the last three quarters. Like many oil & gas companies, the firm has negative free cash flow given heavy capital expenditures that are rising from the $850M range. At 17.2x 2011 operating cash flow, the company also isn't cheap excluding the price of land acquisitions.

The company now is valued at its target price, which appears more than reasonable. Assuming EPS grows 25% off of the $0.94 2013 EPS consensus, it will hit $1.84 by 2016. If the multiple is 35x, the future value of the stock is $64.40. Discounting backwards by a 10% rate yields a price target of $40. It's hard to justify a 35x multiple in an industry that is ripe with generous dividend yields and low multiples.

Devon Energy (DVN) is an alternative that is worth a look. It trades at a respective 10.9x and 9.1x past and forward earnings. The price target is at a 45% premium to the trading value. Aside from liquidity being fairly strong at a quick ratio of 1.4, Devon is attractive for its natural gas exposure. As I have explained earlier here, the secular trends in the industry are both positive and substantial. The exposure to Permian Basin is a major catalyst given expectations for 30% oil growth in 2012. The 1Q12 miss of 27.1% was, however, devastating in light of decent performance in the preceding four quarters. At the same time, the 18.9% decline over the last three months appears to be overblown.

The Permian Basin isn't the only catalyst that Devon has going for it. The firm is developing the Barnett Shale and has been so pleased with the results that it is increasing exploration. Like other companies willing to take a contrarian approach, Devon has unabashedly sought natural gas instead of meaningfully diversifying elsewhere.

Assuming EPS grows 7.9% off of $6.24 next year, it will hit $8.47 by 2016. At a 12.5x multiple, the future value of the stock is north of $100. Discounting backwards by a WACC of 10% yields a present value/price target of $65.74. While this provides less than the 20% margin of safety recommended for value investors, it still is decent in light of my belief that analysts aren't bullish enough about natural gas.

EOG Resources (EOG) is more expensive than Devon but far cheaper than Cabot. It trades at 1.8x book value and is currently rated near a "buy". The target price on the firm is $124.26. If EPS hits $12.44 by 2016, a 12.5x multiple would put the future value at $155.50. The price target would only be justified under those assumptions if the discount rate was a very low 4.5%. At a more reasonable 10% discount rate, the present value of my 18.6% growth assumption would be at just an 8% premium to the current market value. This is not worth the risk of investing in a firm with a low quick ratio of 0.9.

By contrast, Chesapeake (CHK) is both cheap and highly valuable. It is valued at only 7.4x past earnings and 30% less than book value with a 2% dividend yield. Assuming 15% EPS growth on top of the $1.70 EPS expected in 2013, 2016 EPS will hit $3.42. A 12.5x multiple would put the future value at $41.04. Discounting backwards by 10% yields a fair value of $25.50 - in-line with consensus. It would take nearly a 15% discount rate to make Chesapeake's current value justifiable. I thus strongly recommend opening a long position in the 2nd largest natural gas producer. This long position should be complemented with additional ownership in Devon.

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

Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.

Source: Devon, Chesapeake Ideal Natural Gas Plays Over Cabot, EOG