Natural Gas Is on the Rise—And Huge Gains Could Be Lurking in This Dead Sector
Contributed Opinion

The oil price gets all the press. The price of a barrel collapsed during the Covid-19 lock down. Companies went bankrupt in droves. Now, the industry turned to mergers to survive.

Investors fled. The sentiment turned awful. No one cares about oil anymore. The future is electric cars…peak demand is right around the corner.

Right or wrong, the oil industry is deep in a bear market. And that brings opportunity.

For example, one unintended consequence to this collapse is a major decline in natural gas production. According to the Energy Information Administration (EIA) data, we haven't seen this big a drop in natural gas production since 2008.

From February 2020 to May 2020, U.S. natural gas production fell 8%. That's the largest three-month decline since 2008.

That's important, because consumption isn't falling.

Natural gas is important because it heats nearly half the homes in the U.S. The bulk of U.S. natural gas, about 60%, goes to electric power and homes. The rest goes to industry and commercial users.

If we look at July 2020 consumption data (the latest available) it's up 4% from July 2019. In general, consumption in 2020 is down just 1% over the same period in 2019, even with the pandemic. That's a huge contrast to oil demand. U.S. liquid fuel demand fell 23% in the first half of 2020.

And the EIA expects demand to continue to rise into 2021.

That's driving a rise in natural gas prices, as you can see here:

The question is, how do you play it, as an investor?

After a little research, I came up with six potential investments. Natural gas make up at least 40% of their production mix. And they are all profitable over the past 12 months. But there's a definite division in price to earnings:

I sorted the companies based on their enterprise value divided by trailing 12-month free cash flow. That gives us a realistic price to earnings snapshot. The key is that this measure includes debt. That's important because most of the exploration and production companies carry debt.

For example, Par Pacific Holdings has a $395 million market cap, but holds $1.1 billion in debt. That's why its enterprise value (EV) is 31 times its free cash flow (FCF). EQT carries $4.7 billion in debt and Cimarex carries $2.2 billion in debt. That's why their ratios balloon so much higher.

In contrast, Blackstone Minerals has just $323 million in debt. W&T Offshore has $636 million and Dorchester has just $2.3 million.

That's why those companies are so much cheaper by that price to earnings metric. And here's the critical part…those companies usually trade at a much higher EV to FCF ratio.

For example, since 2016, Blackstone Minerals' average EV to FCF ratio was 27. At 27 times free cash flow, its market cap should be over $9 billion right now. That's 592% above its current price.

Since 2016, W&T Offshore traded for an average 28.5 times free cash flow. That means its market cap should be around $3.3 billion. That's an incredible 1,335% above its current price.

And based on Dorchester's average ratio of 11.7, its market cap should be around $664 million. That's an easy 84% from today.

That's the kind of set up I like best in natural resources. We have a hated or ignored sector. In this case, natural gas is the baby thrown out with the oily bathwater. And we have a group of companies that are still profitable.

In this case, they are trading well below their average, because of market sentiment.

Sentiment can change quickly. A cold winter, like we are expecting, will continue to drive the natural gas price higher. And the rising price could be the ticket to send these stocks soaring.

--Matt Badiali

Matt Badiali is a geologist and independent financial analyst. He spent fifteen years researching and writing about great investments inside the natural resources sectors. He can be reached at www.mattbadiali.net.

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