Making Money from Passing Gas

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Natural gas, that is.

Below is my favorite chart regarding the US natural gas industry.  

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That big blue wedge labeled “shale gas,” to me really spells O-P-P-O-R-T-U-N-I-T-Y.  So how do you make money on America’s growing shale gas industry?  Certainly, investing in natural gas producers is one strategy. However, not all natural gas producers are created equal.  EXCO Resources (NYSE: XCO) has been clobbered over the past two years, largely due to the drop in natural gas prices and some ill advised financing terms.  Cabot Oil and Gas (NYSE: COG), in contrast, has performed well and popped 10% the other day when it reported favorable earnings.  How to know which producer will be the winner or loser?

A Safer Investment Strategy?

Perhaps a safer investment strategy centers on natural gas pipeline companies.  After all, regardless of who extracts it, natural gas needs to be moved from the field to the customer and pipeline companies are paid to do just that.  Let’s look at three examples.

Williams Partners (NYSE: WPZ) is an interesting play.  This outfit handles 14% of America’s natural gas, including gas produced in the Rockies, the Gulf of Mexico, and, increasingly, the Marcellus Shale.  That last bit about Marcellus Shale interests me because Cabot recently announced record gas production from its Marcellus operations and Williams looked to be the company to transport it to market.   If Williams handles Cabot gas and Cabot gas production grows, seems to reason Williams will grow, too.  This should help offset the expected decline in Williams’ FY2012 earnings.  Cabot gas will also likely help Williams’ 6% dividend (which has generally grown since 2006).  While a tad expensive at 17 times earnings, the company records little debt and has averaged a net profit margin of about 21% over the past five years.  Williams grew nicely over the past two years, although it’s now about 18% off its 12 month high.  This decline off the 12 month high may represent a buying opportunity.

El Paso Pipeline Partners (NYSE: EPB), owned by Kinder Morgan (NYSE: KMI), operates natural gas pipelines in the western and southeastern US.  El Paso has reported generally improving earnings on an annual basis over the past three years.  Also, The Street reports El Paso sales and earnings grew faster than the average competitor over the past year.  Others have noticed this revenue/earnings growth as the stock trades at a little over 18 times earnings.  However, El Paso’s five year net profit margin comes in at an industry leading 36% and dividends have grown from $0.15/sh in 2008 to $0.58/sh in the latest quarter of 2012. The current dividend yield is 6.4%.  The stock lags Williams in terms of capital gains, but hasn’t been as volatile, either.  El Paso represents a steady performer style of investment.  Hopefully, its acquisition by Kinder will result in administrative efficiencies that will drive earnings even more.

Lastly, what about Kinder itself?  After all, it describes itself as the country’s largest natural gas pipeline company.  Analysts view its acquisition of El Paso as a bet on natural gas growing and competing with oil as the American fuel of choice.  To be sure, in terms of pipeline miles, it should provide favorable returns to investors.  However, acquisitions cost money and Kinder carries a relatively high debt load.  Net profit margin falls below industry averages and Kinder pays a 4.15% dividend, less than Williams or El Paso.  That said, Kinder’s pipelines are geographically diverse and should position Kinder well to profit from America’s growing natural gas consumption.  Kinder’s infrastructure will also allow it to benefit if natural gas producers extract either dry or wet gas, Given Kinder’s stock performance and its recent earnings disappointment, this company would be more an investment in forward strategy (betting on continued natural gas production and consumption) rather than an investment in a long term proven performer.

Bottom Line

US natural gas production and the subsequent price drop has spurred increased consumption by electric utilities and chemical companies.  Even Mexican utilities import increasing volumes of American natural gas for their electricity generation.  Despite recent price increases, natural gas will likely be a growing presence in the US economy.  Regardless of who extracts the gas, pipeline companies benefit from the increased production. The trick, of course, is picking the right investment.  Williams represents a steady performer down on its earnings but with interesting Marcellus Shale prospects.  El Paso is a steady performer and dividend payer that may grow earnings and dividends on the benefits of its merger with Kinder Morgan as well as on pipeline operations.  Kinder Morgan is a bet that corporate management is correct in its apparent belief that natural gas is the energy of the future.  

Not a bad set of investment choices and one of these companies certainly belongs in almost anyone’s portfolio.

dylan588 is long Cabot Oil and Gas. The Motley Fool owns shares of Kinder Morgan. Motley Fool newsletter services recommend El Paso Pipeline Partners LP and Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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