Attention Contrarian Investors: Are Natural Gas Companies About to Soar?

Peyto Exploration and Development Corp. (TSX:PEY) is among high-quality, undervalued natural gas stocks that will skyrocket should natural gas prices rise.

Karen Thomas, MSc, CFA

Karen is a stock market enthusiast focused on uncovering those stocks that she believes the market has mispriced. She does this through fundamental and quantitative analysis of companies and their industries, as well as a study of future opportunities and trends. She holds a Masters degree in Finance, the CFA designation, and has over 20 years of experience in the investment management industry. Having worked at a major pension fund, as well as two leading mutual fund firms as an analyst and portfolio manager, she has solid investing expertise which she aims to share with her readers.

Published December 12, 2017 8:26 am EST

Natural gas prices have been in the depths of despair for a long time now, hovering at approximately $3 since mid-2016.

Demand growth has been lower than supply growth, so natural gas prices have not had a chance.

But what if things are about to take a turn for the better this winter?

With natural gas storage of 3,695 Bcf as of December 1, this represents a 264 Bcf reduction from last year and is below the five-year average, which is a very bullish sign for natural gas prices.

And with producers curtailing production in this low-price environment and a forecasted cold winter, we may continue to see far greater supply declines than the market is factoring in.

Let me turn here to two natural gas stocks that currently have healthy balance sheets, strong and growing production profiles, and quality, low-risk asset bases.

These stocks present us with a very compelling opportunity, as they are trading at depressed valuations given the state of the natural gas industry and the resulting negative sentiment toward these stocks.

Peyto Exploration and Development Corp. (TSX: PEY) shares increased 5.7% yesterday. Maybe the market is starting to pay attention to this high-quality company, which has been at cyclical lows for quite some time.

The stock is down 54% year to date, while cash flow from operations increased 11% in the first nine months of the year, and the company is actually free cash flow positive.

So, being a high-quality $2.3 billion market capitalization oil and gas company with over 90% of its production from natural gas, most of it coming from the Deep Basin of Alberta, this may a contrarian investor’s dream.

With Peyto, we get the lowest-cost intermediate natural gas producer. The total cash cost is $4.11 per barrel of equivalent oil (boe), and Peyto’s capital discipline has clearly paid off handsomely.

And while the dividend yield of 8.8% may not be sustainable, I think a cut in the dividend is pretty much priced in to the shares.

Birchcliff Energy Ltd. (TSX: BIR), which rallied 5.5% yesterday, is another very strong contender in the natural gas industry, with expected production growth of almost 40% in 2017.

With a 79% natural gas weighting, a solid balance sheet, low-cost operations, and visible growth ahead, the company is a solid investment for exposure to natural gas.

Cash flow per share in the third quarter of 2017 was $0.24 compared to $0.33 in the prior quarter, as natural gas prices were weaker, but the company has been successful at continuing to bring down its general and administrative expenses, which fell 24% to $0.82 per barrel of oil equivalent.

So all in all, Birchcliff is another example of a quality company in a battered industry that may be at the cusp of some kind of a recovery — just what the contrarian investor looks for.