Natural Gas Is Heating Up:
Christopher Edmonds
Natural Gas Is Heating Up
By Christopher Edmonds
Special to TheStreet.com
9/15/00 3:04 PM ET
URL: thestreet.com
As goes the price of natural gas, so go the prices of natural-gas stocks.
Take the performance of Anadarko Petroleum (APC:NYSE), a leading oil and gas exploration and development company in the U.S. Its stock is up more than 90% this year, compared to the flat performance of the S&P 500. Most of that run has been in the past two months, almost in step with the rise in natural gas and oil prices.
Anadarko on a Run
Other gas companies have followed suit: Apache (APA:NYSE) has gained nearly 75%, Cabot Corp. (CBT:NYSE) is up nearly 70%, and EOG Resources (EOG:NYSE), the recently weaned natural-gas gathering arm of Enron (ENE:NYSE), has soared nearly 120% since January.
And while the rising price of natural gas will help the earnings of these companies, the recent price ascent has placed earnings multiples at historically lofty levels.
Still, one analyst says, there's time to join the party. You just have to work a little harder to find value. The analyst, John Olson of Houston's Sanders Morris Harris, should know. He's seen the gas business cycle more than once.
Olson has followed the energy industry for the better part of two decades and has been an Institutional Investor all-star in both the natural-gas and oil sectors, and his gas team was named the best in the Greenwich Associates 1998 institutional survey.
He's an old-style value investor in an industry where valuation remains key. "I'm a great disbeliever in ever paying 50 times earnings for anything," he says. "You want to ferret out the companies that are unique stories that haven't been discovered yet. Granted, that is becoming more difficult."
However, Olson thinks he has three names that meet the challenge. (Olson's firm has not provided banking services to any company mentioned.)
Gas, Texas Style
Olson's first idea is buy-rated Houston-based Mitchell Energy & Development (MND:NYSE). "This is the last of the Texas gas gatherers," says Olson, reminiscing that its one-time peer, Texas Oil & Gas was the best-performing stock on the New York Stock Exchange from 1960 to 82. He thinks Mitchell presents a similar opportunity.
Mitchell's drilling rights are all local, which eliminates the surprises sometimes found at exploration and production companies with foreign exposure. "All of its assets are in Texas. They don't have assets in far away, strange places."
Texas gas serves Mitchell well. Mitchell spends 50 to 60 cents to find and gather gas and sells it for about $5 per million BTUs today. Delivery is simple because the bulk is peddled to companies like Dallas-based TXU Corp. (TXU:NYSE) for use as fuel in power plants. "With those numbers, the returns on equity are enormous," he says. And, the gathering shouldn't end anytime soon. Mitchell's gas reserves increased 45% this year with another 7,500 locations yet to drill.
Mitchell Finds Texas a Real Gas
And the company remains cheap. Last year, he estimated Mitchell would earn $1.25 a share in 2000. Now, he estimates the company will earn $3.65 per share this year and $3.85 next year.
Currently at $47, Mitchell trades at about 11.4 times next year's estimates. "If you look at the major E&P companies, they trade at 18-20 multiples, some higher," says Olson. "And Mitchell is more profitable and its assets are all in one place."
One more thing: Mitchell may be for sale. "George [Mitchell] has an agenda," Olson says, noting the chairman recently turned 80 years old. Olson estimates the company's value is at least $57 per share to a possible suitor.
Gas in the Heartland
Olson also likes Oneok (OKE:NYSE), rated strong buy, a traditional gas retailer based in Oklahoma. However, what Olson likes most about Oneok is its move to diversify into the unregulated portion of the gas biz.
"They own 88% of the Oklahoma retail gas market and 67% of the Kansas gas market, which has done very well," says Olson. "However, they are growing the marketing side of the business exponentially."
Oneok Diversifies, Goes Up
Olson notes the company has increased its unregulated gas operations from 30% to 70% of its business. "Last year it spent $750 million to build its unregulated gas businesses," he says.
Olson sees the company earning $2.65 this year and $2.85 in 2001. And, again, value is key, with the stock trading at just 13 times next year's earnings. "We think the stock can go to $45 without much challenge."
CMS Comes South
Olson's final candidate has a contrary bent. CMS Energy (CMS:NYSE), also rated strong buy, is best known for its Consumers Energy unit, a regulated electric utility in Michigan. However, like Oneok, the company is quickly developing a major presence in the oil and gas business -- both exploration and production as well as transportation.
None of that is recognized in the price. "A world-class miserable performer last year and the first half of this year," says Olson.
A Contrary CMS
However, Olson says CMS Energy's move into the gas business should turn things around. The company has 3,445 wells that produced the equivalent of 12.1 million barrels of oil and 26.5 billion cubic feet of gas last year, and continues to grow. "CMS is an excellent gas play both the because of the liquids business and its growing marketing business. A contrary play like this in front of winter isn't all bad."
With earnings estimates of $2.50 this year and $2.75 next, the stock is the deepest value in Olson's stable, trading at less than 10 times estimated earnings. And, its dividend will catch the eye of value investors as well. "A nine-plus multiple with a 5.5% yield in a gas market that is going a bit bonkers is a pretty good catch," he says.
It's clear that value is at the essence of John Olson's success. "Why pay 50 times [the price] for something you can get a lot cheaper," he says. "As Elvis Presley used to say, 'Why buy a cow when you can get milk through the fence.' "
Or gas from the ground.
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Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds . |
