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Despite Energy Mania, Insiders Buy Two Natural Gas Plays
By Michael Brush
Exclusively for InvestorIdeas.com
April 10, 2008
With energy and many energy related stocks trading at or near all time highs, we haven’t noticed much buying in this sector for a while.
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So when insider buys happen, they stick out like…well an SUV in the parking lot of a Sierra Club meeting.
Just a few days ago, our old guide on when to buy one of the best-positioned North American natural gas plays -- Chesapeake Energy (CHK) --was at it again. The guide, Chesapeake chief Aubrey McClendon, made more of his typical mega-purchases in Chesapeake stock.
I first began suggesting investors should get long exposure to Chesapeake on the strength of McClendon’s buying back in 2005, when the stock was in the low- to mid-$20 range. (McClendon had been making mega purchases for years, so I already seemed late the story.) The stock then moved into a three-year trading range capped at $35-$37. Recently, the stock broke out. It now hovers in the $49-$50 range, for a double since mid-2005.
Is it time to sell? Sure, stocks that move up so much, so fast tend to retrace. But if you have the patience to be a long-term investor, it makes sense to hold or buy more. That’s what our guide is telling us.
McClendon just bought $22.8 million worth of stock at $45.75 on April 2. He was also a big buyer back in late February and early March – purchasing over $50 million for about $45.25-$46.50. It’s not just the size of his buying that sticks out. He’s got a good sense of timing, too. As you’d expect from a good guide, his purchases portend a 40% advance in six months time on average, according to Thomson Financial.
That’s no guarantee it will happen again, of course. But I’m guessing there’s a good chance this stock could move above $60 within a year, and reach into the $90 range over the next few years. Here’s why.
The stock looks cheap. Chesapeake trades at about 14 times 2008 earnings, compared to a price earnings ratio of 17 times for other exploration and production companies, partly due to its high debt levels. But I’m not too concerned about the debt for two reasons. First, time and again McClendon and his geologists and engineers have shown a knack for finding new gas and oil reserves. (More on that in a second.) Next, Chesapeake is an aggressive hedger. It has locked in contracts for about 70% of its 2008 gas production at about $8.80 per thousand cubic feet (MCF), and 40% of its 2009 production at $9.15 per MCF. It will have the cash flow to handle its debt.
Chesapeake is clearly a leader. It is the number one independent natural gas producer in the U.S. and the number one driller. It has the highest production growth among large-cap energy plays. It recently upped guidance on production growth to 21% growth in 2008, and 16% growth in 2009. Chesapeake has rapid reserve growth, too. Reserves grew 21% last year, and there’s more on the way.
The stock could double from here. At a price of $9 per MCF for gas, or around current levels, the company has $29.2 billion worth of proved reserves and $29.7 billion in unproved reserves, which suggests a share price of $90. It will take a while to get there – years, in other words – but given the inherent shortages of natural gas in North America it seems likely that prices will remain high enough to propel the stock there. Deutsche Bank Securities analyst Shannon Nome believes the stock could hit $65 in the next 12 months.
Haynesville Shale
In early March, Chesapeake announced a huge natural gas discovery in Louisiana that may hold as much as 20 trillion cubic feet of potential gas reserves.
The discovery was based on geological research and engineering work at Chesapeake over the past two years which suggested the company could make big finds in shale that’s younger than the normal target shale. Haynesville shale is about 150 million years old, compared to an age of around 350 million years for the Barnett, Fayetteville and Woodford shale being worked by Chesapeake and other energy companies.
McClendon told investors the Haynesville Shale discovery and several others the company announced around the same time could be "the most important operational announcement" in the company's history.
Chesapeake estimated that its 200,000 acres in Haynesville could contain 7.5 trillion cubic feet of gas reserves. But that it could rise to 20 trillion cubic feet if the company can increase its holdings there to 500,000 acres. The company announced three other natural gas discoveries and five new oil projects at the time it revealed the Haynesville find.
Chesapeake already has several productive plays in Barnett and Fayetteville shale, in Pennsylvania's Marcellus shale and the Appalachian Basin. In the coming months it is likely to reveal new projects and reserves in the Anadarko Basin and elsewhere, and several new oil plays.
Abraxas Petroleum (ABP)
While shareholders of Chesapeake are popping the champagne corks, owners of another natural gas and oil play, Abraxas Petroleum, haven’t been so fortunate. Their stock is down 35% since early November.
What’s the problem? Abraxas recently formed a limited partnership called Abraxas Energy Partners, floated about half the shares privately, and transferred assets into the partnership. The transaction helped Abraxas refinance and pay off its debt. Abraxas plans to spin off the partnership, but so far has held back.
Confusion about the partnership and a distaste for small cap names as well as energy limited partnerships help explain why Abraxas has lagged, chief executive Robert Watson recently told investors. “The market just doesn’t understand the new Abraxas petroleum story,” he said.
One insider seems sure the market has it wrong. A director recently purchased $164,000 worth of stock at around current levels, or $3.29 per share. This is around the level where insiders historically have purchased this volatile name before its next move up.
Watson recently cited the following reasons why his company’s stock should trade higher.
- It recently posted its fifth consecutive year of earnings.
- With the help of an acquisition, it increased production 60% in the last seven months of 2007. Formation of the energy partnership made the acquisition possible, and as cash distributions from the partnership to Abraxas rise, so should its stock.
- The company increased crude reserves last year by 8%.
The bottom line: Just look at the charts and you can see that both of these are volatile stocks, as are many energy plays. There are two takeaways in this: 1) you need to have strong nerves to be in these stocks and 2) with patience, you can pick up the stocks at a discount.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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