Time to Look at a Natural Gas Play

With natural gas at insanely low levels, there is value in the sector. I have a potential play on it.

Here is a fantastic post on the inevitable natural gas price spike courtesy of Chris Nedler at getREALlist

Here is the basics on supply/demand/pricing from the post:

Now I am seeing the same pattern in natural gas (or as traders sometimes call it, “natty”), only the danger of constrained supply is possibly even greater, since about 84% of US natural gas consumed is produced domestically and there is very little storage throughout the system.

Gas prices have plunged 72% from their record of over $13 per Mcf1 to $3.75 on Monday, taking it all the way back to 2002 pricing. (The spot price for natural gas has only fallen below $4 once since 2002, in September 2006.)

All that got me to thinking. How to play gas? I could go with the producers of it but since most of them can’t make money with gas under $6, an 80% rally in natural gas prices would do little for their fortunes (except keep them from Chapter 11).

I could play natural gas itself but it can rally to a level and just sit there while affiliated stock keep making money for shareholders.

We can substitute oil for natural gas and all of the above would be true also.

What then? Oil Well Services and Equipment. All producers need serviced on existing wells and close wells. When prices rebound, the corresponding increase in well activity will be a boon for these companies.

Enter Exterran Holdings, Inc. (Public, NYSE:EXH).

From the 10K:

We are a global market leader in the full service natural gas compression business and a premier provider of operations, maintenance, service and equipment for oil and natural gas production, processing and transportation applications. Our global customer base consists of companies engaged in all aspects of the oil and natural gas industry, including large integrated oil and natural gas companies, national oil and natural gas companies, independent producers and natural gas processors, gatherers and pipelines.

We operate in three primary business lines: contract operations, fabrication and aftermarket services. In our contract operations business line, we own a fleet of natural gas compression equipment and crude oil and natural gas production and processing equipment that we utilize to provide operations services to our customers. In our fabrication business line, we fabricate and sell equipment that is similar to the equipment that we own and utilize to provide contract operations to our customers.

We also utilize our expertise and fabrication facilities to build equipment utilized in our contract operations services. Our fabrication business line also provides engineering, procurement and construction services primarily related to the manufacturing of critical process equipment for refinery and petrochemical facilities, the construction of tank farms and the construction of evaporators and brine heaters for desalination plants.

In what we refer to as “Total Solutions” projects, we can provide the engineering design, project management, procurement and construction services necessary to incorporate our products into complete production, processing and compression facilities. Total Solutions products are offered to our customers on a contract operations or on a turn-key sale basis. In our aftermarket services business line, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression, production, gas treating and oilfield power generation equipment.

Why Exteran?

Valuation:
Even after writing off $1.1 billion in Gooodwill due to market conditions in Q4, Exterran still sports a book value of $32 a share. At the current $17 share price it trades at 53% of book. Cash flow and cash on hand are steady.

Stock Repurchase Program.

On August 20, 2007, our board of directors authorized the repurchase of up to $200 million of our common stock through August 19, 2009. In December 2008, our board of directors increased the share repurchase program, from $200 million to $300 million, and extended the expiration date of the authorization, from August 19, 2009 to December 15, 2010. See further discussion of the stock repurchase program in Note 15 to the Financial Statements. Since the program was initiated, we have repurchased 5,416,221 shares of our common stock at an aggregate cost of approximately $199.9 million. See Part II, Item 5 (“Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”) of this report for information regarding our fourth quarter 2008 repurchases.

Ownership:
Nearly 45% of the stock is owned by 5 groups including 8% by ValuePlays favorite Seth Klarman’s Baupost Group.

Now, is this a “run out and buy some”? I don’t think so but I am keeping it high on the radar list. While both oil and natural gas are at unsustainably low levels. History tells us they can remain there for some time. It also tells us that the recovery to appropriate levels can be swift and violent.

As Nedler says:

The time it takes to raise capital for new drilling, deploy rigs, and start producing again after gas prices rise is a golden window of opportunity for investors. As long as marginal capacity remains in a razor-thin range, prices will stay high and low-cost producers will be rolling in profits again.

While it’s impossible to say when the US economy will recover and bring natural gas prices back into sustainable territory, I am confident that for those with at least a one-year investing horizon, there is no better time than now to begin accumulating those positions.

One has to watch economic activity for sign. Q1 will be reported in May and by then more data will be available as to global conditions. It is important to note this is not a pure US play but a global one. As global conditions improve, so ought Exterran’s.

Q4 Earnings release

Full 10K

Disclosure (“none” means no position):