Five North American Natural Gas Buys

Five large cap buy recommendations concentrated on North American natural gas, Anadarko Petroleum (APC), Devon Energy (DVN), Encana (ECA), EOG Resources (EOG) and XTO Energy (XTO), have demonstrated volume growth on a basis that takes account of financing (see chart Volume per Share, Adjusted for Debt and Dividends, below). All have low McDep Ratios ranging from 0.72 to 0.91 with the top growers of the latest quarter coincidentally having the higher McDep Ratios.

Stock prices are in an uptrend by the 200-day average measure despite intense short-term pressure on the price of the companies’ main product, clean natural gas. Potentially rebounding economic activity in 2010 may demand the new volumes not needed today for industrial production or power generation. The large cap North American natural gas independents account for 5 of our 28 buy recommendations. We suggest that one or more might account for 18% of enterprise value in a McDep Energy Portfolio, or perhaps 24% if you like the prospects for natural gas as much as we do.

Since the most recent quarterly disclosures, we have modified our volume measurement technique to smooth the debt factor and to include an adjustment for income. As in the past, the share adjustment gives credit for share repurchase or assesses a cost for issuing new shares. The debt adjustment neutralizes the appearance of growth that may be financed with borrowed funds. Our current method takes incremental debt in a quarter and assumes that it is replaced by a corresponding amount of shares issued at Net Present Value (NPV). As a result, the latest change in NPV affects only the latest increment of debt, not the embedded base. The dividend adjustment, also added since the quarterly disclosures, will become meaningful when comparing low dividend paying independent producers with income stocks.

Meanwhile, the 40-week average for six-year oil has turned up this month to $71. An uptrend can appear stronger when the average itself is moving up in addition to latest price being above the average. Latest settlement prices for the average of futures for the next six years are $83 a barrel and $6.71 a million btu. Natural gas is just under the 40-week average of $6.89. Our five large cap independent natural gas buys are positioned to weather the next few months of potential short-term commodity pressure and to participate in the possible upside thereafter.

Disclosure I am long XTO shares.