Three Undervalued Natural Gas Stocks

Includes: DMLP, HGT, XEC
by: Kurt Wulff

Our long-term investment conclusion is upbeat despite our seemingly downbeat reduction in assumed long-term price of natural gas to $8.00 a million btu from $10.00 previously. That change triggers a reduction of 20% in our estimate of Present Value of North American Natural Gas (NANG). Accordingly, McDep Ratios move up to a median of about 0.74.

Meanwhile, the closest market indication of long-term natural gas price is the average of futures quoted monthly for the next six years. Though that price has averaged $8.00 for the past three years, it has declined to $6.60 on the July 16 settlement. Yet, a median McDep Ratio of 1.0, where stocks would be fairly valued at current prices, implies a long-term price expectation of about $6.00 (8.00 times 0.74). By setting our present value calculations to $8.00, we are saying that $6.00 is too low, $6.60 is too low and that stocks are a bargain.

For immediate action we have three natural gas buy recommendations, Cimarex Energy (NYSE:XEC), Dorchester Minerals, L.P. (NASDAQ:DMLP) and Hugoton Royalty Trust (NYSE:HGT).

Global Trading Indicators Support Oil and Gas Investment
Starting at the most general level, we see the U.S. dollar in a downtrend with the DXY index at about 0.79 compared to the 200-day average of about 0.84. Next, we see inflation expectations in an uptrend as measured by the difference between nominal rates and real rates. Nominal interest rates appear to be in an uptrend with interest on the U.S. Ten-Year Note at about 3.5% compared to the 200-day average of about 3.1%. The difference relative to the real yield on the Ten Year U.S. Treasury Inflation Protected Security appears to be widening. Global stock markets are in an uptrend with most major indices trading above the 200-day average. Emerging markets are leading.

A declining dollar, rising inflation and a positive stock market backdrop are good for oil price with six-year futures trading at $76 a barrel compared to the 40-week average of $71. Reasonable demand expectations combined with a tight supply outlook are also supportive of rising oil price. Natural gas verges on a rising trend.
Combining the global influences, investors see leading performance occurring in non-U.S. and oil oriented stocks and catch up potential in U.S. and natural gas oriented stocks. Given the broadening positive stock price indicators it seems just a matter of time before natural gas stocks join the uptrend.

Originally published on July 17, 2009.