The Smart Way to Invest in Natural Gas

Shares of natural gas companies have marked gains recently as investors looked to signs that demand for this beaten down fuel will go up.

APC, CHK, DVN, SD, SPY Chart by YCharts

Pricey oil, and to a lesser extent, Japan’s nuclear disaster, have pushed up prices for natural gas on speculation that power producers will need alternatives to those fuels. Uncertain political situations in oil producing countries seem likely to keep oil prices high for awhile.

It’s a welcome spark of recovery for natural gas prices, which dropped some 70% between 2008 and 2009 and have wallowed ever since.

Unfortunately, companies in the independent natural gas sector now tend to have issues that make conservative investors nervous.

Some companies have uncomfortable levels of debt coverage. Chesapeake Energy Corp. ( CHK) and SandRidge Energy (SD) have seen current ratios decline recently.

CHK, SD Chart by YCharts

Some companies just look expensive compared to their historic trading levels.

APC, CHK, DVN, SD Chart by YCharts

YCharts Pro rates these and other large natural gas companies as “neutral” because of soft fundamentals at the company level or overpriced shares.

There is a more conservative way to bet on a natural gas recovery. Oil giant Exxon Mobile (XOM) became the biggest producer of natural gas in the country with its purchase of XTO Energy last year. YCharts Pro shows Exxon strong in fundamentals, and it tags the shares as well undervalued.

As a natural gas producer at a time of low prices, Exxon has many of the same problems as the independent producers. But its debt levels and shareholder returns are much more attractive for investors. And as we have pointed out before, Exxon steadily increases its dividend. Its dividend yields typically are at least double that of independents.

APC, CHK, DVN, SD, XOM Chart by YCharts

Exxon usually offers shareholders a higher, and certainly more consistent, return on equity.

APC, CHK, DVN, XOM Chart by YCharts

Finally, Exxon shares are a lot cheaper than those hot natural gas stocks.

APC, CHK, DVN, SD, XOM Chart by YCharts

It’s probably true that an all-out surge in natural gas prices would do more for the shares of independent gas companies than for a gigantic, more diversified company like Exxon. But a real recovery in gas prices is far from certain. There is still a big oversupply of the stuff, and new technologies that make extraction easier only add to the problem. Some economists predict that a global gas glut will last another decade.

Even Exxon, which barely two quarters ago looked to be about equal parts natural gas and oil, stressed recently that the vast majority of its new production in the next five years will be in oil. As the chief executive explained, the company is just following the money.

So go ahead. Make a bet on rising natural gas prices. But hedge it with a really big oil company.

Filed under: Company Analysis