Nine Natural-Gas Bargains

We saw some compelling investment opportunities emerge when many of the natural-gas producers' stocks we covered took a dive last fall. We had more than a dozen natural-gas producers with 5-star Morningstar Ratings in late September and early October. At the time, the short-term outlook was pretty ugly. Natural-gas storage levels were well above the trailing five-year range, following an unusually warm winter and uneventful hurricane season. Spot prices for natural gas fell below our longer-run estimates, while drilling and service costs continued to climb.

We didn't think these conditions fairly represented these companies' longer-term fundamentals, although another unseasonably warm winter would have been painful for some producers. Plus, we thought that market participants using short-term cash flow and earnings numbers to value exploration and production companies were potentially missing the bigger picture. Specifically, some exploration and production firms were adding value (by discovering new reserves, for example) without having earnings or cash flow to show for it.

Over the past few months, many of these factors have swung in favor of natural-gas producers, and the short-term profit outlook has improved. Although the winter started off a bit on the warm side, a bone-chilling February contributed to a large draw-down in natural-gas storage. Also, the rise in drilling and service costs appears to be moderating as new rigs get added to the North American fleet and some producers ratchet down activity. In a nutshell, the short-term earnings picture has improved as upward pressure on natural-gas prices and downward pressure on drilling costs have taken hold.

The market appears to have taken notice too, with many of the exploration and production company stocks rebounding a bit from fall. Some stocks have bounced back more dramatically; for example,  XTO Energy  is up about 30% from the price at which it got a 5-star rating in September. Although the prices of many of these stocks have moved closer to our fair value estimates, we still see a few compelling deals.

As of March 5, 45 energy companies had 4- or 5-star ratings-- click here to see the current list. Below, we focus on a sampling of natural-gas stocks that seem especially attractive. To see a complete list of our 5-star stocks, as well as full Analyst Reports for each of these companies, take a free two-week trial of Premium Membership.

Attractively Priced Natural-Gas Producers
Company	Morningstar     Rating	Fair Value Estimate	Price/ Fair Value	Market Capitalization
Compton Petroleum		$15	0.58	$1.2 billion
Cimarex Energy		$57	0.60	$2.9 billion
Devon Energy (DVN)		$93	0.69	$29 billion
Pioneer Nat. Res. (PXD)		$54	0.70	$4.8 billion
Anadarko Petroleum		$55	0.71	$18.4 billion
Newfield Exp.		$57	0.73	$5.6 billion
Ultra Petroleum		$64	0.77	$7.6 billion
Forest Oil		$40	0.77	$2 billion
EnCana (ECA)		$60	0.79	$41.6 billion
Data as of market open on 03-06-07

 Compton Petroleum 
We think Compton can boost production at an annual rate in the midteens over the next five years. Two positive rulings from the Alberta Energy and Utilities Board in 2006 should help provide a tailwind for Compton's drilling program. The rulings allow tighter well spacing and commingling, which should increase the quantity and size of the wells Compton can drill.
Full Analyst Report:  Compton Petroleum

 Cimarex Energy 
Cimarex had a challenging year with the drill in 2006, posting a far lower success rate than what the firm is accustomed to. At a recent price of $35 per share, we think the market is assigning little, if any, value to the firm's Gulf Coast operations. If the firm can improve its drilling success from 2006 levels, which we think it can, then the shares look cheap.
Full Analyst Report:  Cimarex Energy

 Devon Energy (DVN)
Devon is the largest leaseholder and producer in the Fort Worth Basin, commonly referred to as the Barnett Shale. It's also one of the largest leaseholders in the deep-water Gulf of Mexico. Both the Barnett Shale and deep-water Gulf of Mexico are among the most promising areas for oil and natural-gas production and reserve growth in the United States. Although the Barnett Shale has already begun bearing fruit for Devon, both regions offer additional upside to the firm's future production.
Full Analyst Report:  Devon Energy

 Pioneer Natural Resources (PXD)
Pioneer has shaken up its portfolio of oil and natural-gas properties over the past few years, and we think the shares look cheap. New field discoveries made late in 2006 in south Texas and Tunisia should help the firm drive production higher over the next few years.
Full Analyst Report:  Pioneer Natural Resources

 Anadarko Petroleum 
Anadarko is another firm with a lot of moving parts in its oil and natural-gas property portfolio, making it challenging for investors to see what's ahead. The firm's size nearly doubled after its purchase of Western Gas and Kerr-McGee in 2006. Anadarko has been selling large chunks of its legacy properties in recent months and should quickly approach its pre-deal size. The remaining firm will be focused in the deep-water Gulf of Mexico and the Rocky Mountains--two regions poised for oil and gas production growth over the next decade.
Full Analyst Report:  Anadarko Petroleum

 Newfield Exploration 
Newfield has several high-potential projects that should start bearing fruit over the next few years and accelerate production. Initial drilling suggests that its Woodford Shale play has a similar production profile to the already successful Barnett Shale and Fayetteville Shale. We also expect production gains from its offshore deep-shelf and deep-water prospects, and projects in the North Sea and offshore Malaysia.
Full Analyst Report:  Newfield Exploration

 Ultra Petroleum 
Thanks to its impressive position in the Pinedale Anticline in Southwest Wyoming, Ultra has posted the lowest per unit costs of any of the North American natural-gas producers we've covered over the past five years, translating into impressive operating margins and returns on invested capital. Even more impressive, Ultra has plenty of drilling ahead of it in the Pinedale, and looks poised to reinvest its growing cash flow at attractive returns for many years to come. The firm had a tougher year than usual with its rig operations in 2006, affording investors a chance to purchase the shares at a reasonable price.
Full Analyst Report:  Ultra Petroleum

 Forest Oil 
Then-new CEO Craig Clark launched a turnaround plan at Forest in 2003, shifting the firm's business model away from exploration toward acquire and exploit. Since then, he's cut costs and retooled Forest's portfolio considerably. We're big fans of Forest's acquisition of  Houston Exploration . Clark appears to have negotiated a great deal for Forest's shareholders, acquiring Houston at an attractive price, in our opinion.
Full Analyst Report:  Forest Oil

 EnCana (ECA)
We recently raised our fair value estimate for EnCana after taking a closer look at its oil sands partnership with  ConocoPhillips (COP), its hedging program, and its Alberta taxes. After shedding its international portfolio, we think EnCana's remaining unconventional natural-gas plays in North America could add considerable value over the next decade. EnCana has also been kind to its shareholders; it recently doubled its quarterly dividend and intends to continue with its share buyback program, targeting the repurchase of 3%-5% of its shares in 2007 after buying back about 10% in 2006.
Full Analyst Report:  EnCana