I was worried about rising natural gas prices for companies that make products with the intentions of unseating oil’s dominant position, but the flip side of that is the benefit to the suppliers.
One of the great things about investing is that a problem in one place can mean an opportunity in another. The companies could only go for the easiest, also known as cheapest, gas available. If the natural-gas price trend continues upward, it can finally lead some stocks much higher.
The extended environment of low prices has meant that these companies have had to operate in a lean fashion, squeezing out savings in costs whenever possible. Natural gas companies have to be far more judicious in their spending, and that experience could work to their benefit in a better price environment.
Hard-luck giant
I have a tendency to like down-and-out companies the best. Even ones that are pretty far gone get my attention. I like to look at them, though I do not uniformly see the good in them–but the potential is enticing.
Chesapeake Energy Corporation (NYSE:CHK) has a new CEO, and one really terrible quarter in 2012 that makes the numbers look worse than they are. Considering the issues surrounding the previous CEO and his departure from the company, there might be some concern that the new CEO did not come from outside the company. However, the bright side is that the new CEO, being the former COO, understands the company’s operations.
Natural gas production accounts for 70% of the company’s total production. The other 30% is called liquids production and is two-thirds oil and one-third natural-gas liquids. Natural-gas liquids are components that are absorbed into gasses such as propane, butane, etc. It’s economic to extract those and sell them. Despite liquids being 30% of the overall production, they were 62% of the revenue for 4Q 2012.
Rising prices should re-balance those numbers as natural gas attracts more money to the company. Also, once the price rises high enough, Chesapeake Energy Corporation (NYSE:CHK) can increase production, which means it can make more money per unit and produce more units of gas by extracting more expensive gas.
Much of the profit from the previous quarter came due to oil. Oil is still going to be the key product for the company for the remainder of 2013, as the price of natural gas is not expected to rise too much. However, there are a lot of forces over the next two-to-three years that could put upward pressures on natural gas, and these will continueas natural gas becomes increasingly important.
Many factories producing LNG and compressed natural gas (CNG) are expected to come online by 2015, and there are potential developments on the political front, as well. The massive beast of a floating LNG plant is likely to be completed by 2017, but it’s gigantic, which is why it is later. Smaller plants will come online sooner.
These overarching factors will work in Chesapeake Energy Corporation (NYSE:CHK)’s favor, and oil will keep the company growing in 2013. Oil is likely to be responsible for 51% of revenue this year, according to the company. A patient investor has the chance to invest in the long game that is natural gas, and you can collect a very modest 1.7% dividend yield in the mean time.
Unraveling the fear
Linn Energy LLC (NASDAQ: LINE) has mostly recovered from its fall down to $36 and shares are now trading in the mid-$38 range. However, the stock is lower than when I first noticed it at above $40. There were some murmurs of accounting problems a few months ago that brought the stock down. It was not a huge decline considering the high dividend and the lack of substantive evidence.
The company managed to increase its distributions and expand its operations in a deteriorating price environment. It seems like sound logic that increases in natural gas prices will eventually work in the company’s favor.
Linn Energy LLC (NASDAQ: LINE) also seems to be beefing up its oil reserves. Its acquisition of Berry Petroleum Company (NYSE:BRY) gives it primarily reserves in oil. That diversity should help it get through the near term, and should allow the company to keep paying its great 7.6% dividend.
Linn Energy LLC (NASDAQ: LINE) is a Master Limited Partnership, with all the tax issues that brings. To avoid the complex tax situation the company uses Linn Co. Dividends are passed to Linn Co and taxes are paid at that level, then distributed to shareholders with the standard 1099-DIV, simplifying things a bit. Linn Co does have a lower yield of 7.3%, and trades separately from Linn Energy with the potential for a premium or a discount. Consult a tax professional for more information.
Splitting the difference with the titan
“Natural gas or oil?” is not an easily answered question. Rather than debate the question, use the certainty of the current oil-based economy and go with Exxon Mobil Corporation (NYSE:XOM), which is huge all around. It provides the safety of being massive, but perhaps its exposure to natural gas can be enough to move its stock.
The three-year return on the stock is 30%, which means moving shares is a Sisyphean task. The PE has been steadily falling as the company increases revenue and earnings. Only recently hastop line growth stalled.
With its massive role in providing both oil and natural gas, I do not see Exxon Mobil Corporation (NYSE:XOM) keeping its 9-and-change PE ratio. It normally hovered at around 15, and it should get back there when the market realizes and appreciates the opportunity. In the meantime the company has a 2.5% dividend yield to reward patient investors. While that is not great, Exxon Mobil Corporation (NYSE:XOM) can be considered undervalued if natural gas prices continue rising along with oil.
Conclusion
Oil is likely to remain important for the next year or two, but over the next two-to-three years an increasing amount of natural gas production facilities will be activated. Expect things like refueling stations, CNG factories, LNG factories, and a whole slew of potential political initiatives for clean natural gas or local energy sources. Chesapeake Energy Corporation (NYSE:CHK) and Linn can benefit from increased diversity from oil, but Exxon Mobil Corporation (NYSE:XOM) is the leader in both oil and natural gas.
Exxon’s stability comes at the price of potential returns. Chesapeake Energy Corporation (NYSE:CHK) has been beaten down and could see capital appreciation, while Linn still has a very high yield. The decision comes down to the role the stock will play in your portfolio and your specific investing style.
Nihar Patel has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy.
