2 Nat Gas Stocks to Buy, 1 to Hold Off From
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Secular trends in natural gas have looked hot for some time. Foreign policy concerns, EPA regulations, and increasing scarcity of oil and carbon have set the tone for a transition to this abundant energy resource. I recommend diversifying now as demand starts to get in. Top producers in the field, include Devon Energy (NYSE: DVN) and Apache Corporation (NYSE: APA). EOG Resources (NYSE: EOG) looks quite a bit more expensive and is too risky for an investment.
Over the past 5 quarters, Devon has beaten expectations 4 times by an average of 10.7%. Yet shareholder value has decline by 6.3% over the last 12 months. Strong returns in the second quarter were driven by excellent production in the Permian Basin and Jackfish projects. At the same time, the firm is doubling down on its bullishness with the purchase of 545,000 acres of leased land on the Mississippian, an Oklahoman unconventional shale play. The site will be developed with Sinopec, which is attractive in terms of reducing risk. Greater porosity in the region has improved development prospects while the financial position is improving in a way that will enable production to soar in the years ahead.
Daily production has already reached nearly 680 mboed in 2Q12 as the management hiked capital expenditures 15% for new drilling. To mitigate risk, Devon has hedged against 65% and 85% of gas and oil production, respectively. This attractive balance of high exposure to natural gas and solid hedging makes Devon perfect for those looking to hedge against macro uncertainty while taking an overall bullish outlook on the energy sector. Although the firm has run into supply chain problems with its natural gas facilities, it optimally used the second quarter to fix those headwinds while still ramping up operations at the Permian Basin.
As attractive as Devon is, Apache is an even more compelling "buy." The firm only trades at a respective 10.9x and 8.4x past and forward earnings. Forecasts for 5.8% annual EPS growth over the next 5 years have set the bar overly low given that earnings increased 8.4% annually over the past 5 years. Analysts are still optimistic on the stock (with what I think are bearish projections) and rate it a 1.8 out of 5 where "1" is a "buy." Gross margins have been on the increase but performance has still been weak in recent quarters with misses of 17.9% and 2.9% in 2Q12 and 1Q12, respectively. Apache has since fallen 16.8% over the last six quarters.
There is strong potential for Apache to head back up to its 52-week high, since the sell off appears to be overblown. Fracking costs are on the decline as new technologies are being implemented. Large geographical diversification reduces risk, and the North Sea, in particular, will be a major catalyst for value creation. Some fear that the North Sea is nearing exhaustion, but this is an overblown fear that has caused the local assets to become considerably undervalued. Having acquired Beryl field, Apache is increasing scale in the region, which will pay dividends through diluting fixed costs.
In contrast to both Apache and Devon, EOG is looking pretty expensive. Although it trades at a respective 22.6x and 21.3x past and forward earnings (which is high for any company, let alone an oil & gas producer), analysts are still recommending buying shares. 13.8% annual EPS growth is forecasted over the next 5 years despite low single-digit losses during the past 5 years. In my view, the growth, as evidenced by the 1.7x PEG ratio, is not enough to justify the current multiples. Free cash flow over the past 5 years has averaged nearly -$900 million. TTM performance has been especially weak over the last two years with no sign of a turnaround. Accordingly, I recommend holding out until more visibility emerges and buying Devon and Apache instead.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Apache and Devon Energy. 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.