Since the middle of September, natural gas prices have been in a very strong uptrend. Aided by an unusually hot summer, natural gas inventories fell back in line with the five year average. Additionally, the latest rig reports warn of a potential shortage, as we have not seen this rig count level since 1999. Last year we saw the rig count come in at 936, this year we are currently at 422. If the number of rigs continues to decline, we should continue to see a steady rise in natural gas.
I believe natural gas will be a great investment for the rest of 2012 and beyond. Currently, we are seeing support for higher prices from the lower rig count and a potentially cold winter. However, I do think we could see a minor pullback in the short term before the run up in winter.
There are a number of ways to play natural gas but let's look at Chesapeake Energy (CHK). While the company had a rocky start to the year, it seems it has revived along with the price of natural gas. Currently, Chesapeake is trading at a market cap of $14 billion and offers a yield of 1.7%. Furthermore, the company has a price to earnings ratio of 7, PEG of 0.93, price to book of 0.78 and a price to sales of 1.09. These valuation ratios outpace other viable competitors such as Apache (APA), SandRidge Energy (SD), EOG Resources (EOG) and Devon Energy (DVN). However, much like Chesapeake, these companies will receive a boost from an uptrending natural gas.
Chesapeake had to take out a $4 billion bridge loan back in May when the company was spiraling downhill due to a diving natural gas price and corporate scandals. However, as of this week, the company announced that it was "very close" to paying off the balance and, additionally, expects to pay off its total debt by the end of 2012. This is great news as it shows that the loan did its job by helping Chesapeake get back on its feet. Critics of Chesapeake often target the fact that the company likes to horde properties with sometimes no intent on producing right away. What they do not understand was that the company has been forecasting higher natural gas for some time, over the long term. Earlier this year and last year, natural gas prices were so low that it would actually have cost more money to drill out the natural gas than to sell it. Now that prices have risen from $2 BTU to its current $3.85 BTU and profit margins are starting to become more attractive. The key to a higher stock price for Chesapeake is through higher natural gas prices. If Baker Hughes (BHI) continues to show the rig count falling, this could aid prices to the north.
While Chesapeake is the undervalued play, Devon Energy is a more value approach to playing natural gas. Devon is worth $24 billion and has a dividend yield of 1.34%. The company sports a low price to earnings of 10, PEG of 1.5, price to sales of 2 and a price to book of 1. As you can see, Chesapeake is cheaper but Devon has a rich portfolio of properties that are producing large amounts of oil and gas. Specifically, Devon has been stepping up its oil production in the Permian Basin and Canadian oil sands. Likewise, the company reports healthy production results from its Barnett Shale property and expects to have another Jackfish oilsand property up and running in 2014. The bottom line here is that everyone thinks of Devon as a natural gas based energy firm but the recent success and increasing of oil output gives the company a huge chance at a higher valuation. As you may be able to tell, Devon may not be as cheap as Chesapeake but there is certainly a lot of growth potential with the number of successful properties.
Taking another look at the underlying commodity, I see some potential risks in the short term to natural gas prices due to the fact of falling energy prices. Crude oil has taken a major hit over the past few weeks as economic uncertainty continues and demand shrinks. Oil currently trades at around $86 a barrel. Gasoline has been in a downtrend for most of October and shows no sign of letting up - prices currently around $2.60. Heating oil is also in a downtrend and looks to be adding to losses as well. I mention this because the overall performance of a sector can influence individual commodities and their performance. Likewise, energy is tied to economic growth and the recent warnings around the world have not signaled strong growth. To be sure, I expect this downtrend to weaken as we head more and more into the colder months, so be sure to keep an eye out for the reversal upward.
The bottom line here is that when natural gas prices are in an uptrend and estimated at a continued rise, look for undervalued and solid fundamental stocks that will benefit. Chesapeake represents an undervalued play on natural gas, while Devon Energy serves as a value pick after the continued success it has seen in its properties. As I stated before, I think we could see a slight pullback in natural gas prices along with the rest of energy. However, I expect to see prices rebound to the upside as the winter months begin to settle in. Look for the uptrend confirmation in the coming weeks in the form of continued reduction of rigs and reports of a colder than originally estimated winter.