Collecting Profits From Cheap Natural Gas

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

There is no question that the process known as hydraulic fracturing (fracing) has created access to oceans of natural gas within U. S. shale formations that were previously uneconomical. The only remaining question for investors is how to best position ourselves to profit from the changes this cheap energy source will cause in our economy and our lifestyles. Here are four companies that will drive some of those inevitable changes and offer a wide range of risk/reward profiles to satisfy the appetite of just about any investor.

Not for the faint of heart

For those willing to take higher risk with the chance of huge returns, Westport Innovations (NASDAQ: WPRT) provides an opportunity for intelligent speculation. The investment is intelligent because this company owns the patents for some of the most effective products used in converting diesel engines to run on natural gas and boasts Cummins (NYSE: CMI) as a major customer. However, the financial performance is what makes it speculative.

There is really little question regarding the value of and need for Westport’s products and patents; but, the projected losses of $1.56/share and $1.26/share for 2013 and 2014 respectively, do provide investors a reason to pause.  After all, the dust bin of history is replete with examples of businesses that had exceptional products or technology but not the expertise to deliver them to the market at a profit. Until Westport has displayed the ability to do so, it is not an investment for the faint of heart.

However, given intellectual property owned by the business, even if Westport were to end in bankruptcy, the technology to convert diesel engines to natural gas will live on and it is the value of this property that is tantalizing to investors today.

Providing access to the gas provides access to profits

Fracing is the process of injecting water and particulate matter under very high pressure into the shale formations for the purpose of breaking the shale apart and allowing the trapped pockets of gas to flow through the cracks created so that it can then be recovered. One of the fastest growing companies in this industry sector is C&J Energy Services (NYSE: CJES). C&J specializes in providing fracing services to the drilling and production companies. They get paid for their service without regard as to the productivity of a particular well.

C&J’s rapid growth is creating the need to constantly add new capacity which means their equipment is relatively new and reflects the latest advancements. This provides them with a competitive advantage in the market.

With a forward price to earnings estimate of 6.98 and a price to cash flow multiple of 4.9, this stock is simply too cheap to ignore. The annual earnings growth rate for the next 5 years is projected to be 20% so this business is priced to deliver excellent returns for those who buy now.

The smartest player in the game

ExxonMobil (NYSE: XOM) is one of the most successful businesses in history and their shrewd actions over the years exemplify the reasons. The management of this business has a spectacular record of buying and developing new resources when market prices are low and selling the oil and gas when market prices are high. They are unmatched in the industry.

As a result of acquiring and developing assets when demand is low, Exxon has also been able to construct a cost structure surrounding these assets that allows them to maintain profitability even when market prices collapse. This is a crucial advantage in an industry subject to massive boom/bust cycles. Exxon is one of the largest producers of natural gas in the world and a great way to own natural gas within a volatile market.

With a price to cash flow valuation of only 6.3, a 2.56% dividend yield that has been growing 9.74% annually and a very conservative payout ratio of 22%, Exxon provides excellent prospects for income and capital gains for years to come.

The safest of the safe

Cummins is one of the biggest names in diesel engines; lesser known is their entry into the market for natural gas engines. Even though I am sure there will be many who will wonder how I can call an engine maker the safest of the safe, I believe it to be the case.

Cummins is partnering with Westport Innovations and producing engines to run on natural gas in fleet applications. The fuel cost savings are astronomical. While it is true and desirable that natural gas engines are much cleaner than diesel, these conversions are being performed solely as a cost savings move on the part of the purchasers and creates a situation where, if the economy is very good, the freight companies will run more miles and save more money by owning trucks running on natural gas. If, however, the economy is poor, transportation businesses will need to cut costs aggressively without reducing service levels to customers and what better way to do that than slashing fuel cost incurred on a per mile basis by using natural gas?

With a forward price to earnings ratio of 11 and a price to cash flow multiple of 10.2, Cummins carries a very reasonable price for such a well-positioned business. The 5-year forward earnings are only projected for 7.9% annual growth, but I believe those estimates are far too conservative given the improving economy and the economics that will drive this business going forward.

Final thoughts

Those investors who seek safe stable profits and wish to allocate funds to the blossoming natural gas industry will be hard pressed to beat an equal allocation among C&J Energy Services, Exxon and Cummins.

For those with a high tolerance for risk, a thirst for some excitement in their investments and a legitimate shot at huge returns from an intelligent speculation, Westport Innovations might be just what you are hoping to find in the natural gas explosion.

Ken McGaha has uncovered put options on shares of Westport Innovations . The Motley Fool recommends Cummins and Westport Innovations. The Motley Fool owns shares of Cummins and Westport Innovations. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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