Three Plays on Nat Gas

Tom Jacobs and Jeff Annello are analysts and portfolio managers at Complete Value Investor, a value-oriented investment service that buys "50-cent dollars." They just issued buy recommendations on ATP Oil & Gas (ATPG - commentary - Cramer's Take), Contango Oil & Gas (MCF - commentary - Cramer's Take) and Chesapeake Energy (CHK - commentary - Cramer's Take), all of which they own. Here is an edited transcript of why these E&P companies are compelling values for patient investors.

Oil and natural gas prices are down. Why buy these companies now?

Jacobs: We like "down." We're not interested in companies everyone wants at high prices. There's no margin of safety, which Ben Graham advised. Instead, we want to buy good businesses cheap.

In 2006 and 2007, energy investors believed trees would grow to the sky. Today, they believe they will grow upside down. Well, they were wrong before and they are wrong now. Anyone who thinks natural gas will never be $7 per thousand cubic feet (mcf) again or that these companies don't have the balance sheets to survive until then are wrong. Good for us -- we get valuations unseen in decades, and most likely for the last time.

Annello: The market often discounts far worse events then are likely to occur. We're seeing that now more than any time since 1973-1974. Once a stock falls off a cliff, we look to see if the market has overreacted. In recent weeks, the answer is often "yes." Few sectors have dropped like energy stocks. For example, ATP just sold less than 10% of their proved reserves for $430 million cash, which is more than two times their entire current market capitalization. Unless you think their executives are bandits, the valuation is crazy.

Let's go through your reward-risk analysis for each company. Start with ATP.

Annello: Net asset value approaches $50 a share, or about 7 times the current quote of $7, after taking out debt. And this isn't a "believe us" number, but what you get extrapolating ATP's recent asset sales to its remaining reserves. Even when we made extremely conservative assumptions we couldn't get anywhere close to the price ATP trades at today, between $5 and $7 a share. ATP's discount to net asset value is so big that oil and gas could be $40 a barrel and $4 per million BTU (mmbtu) (vs. $5.60), respectively, and the reserves are still worth more than today's market price. The company has sold some interests in the North Sea for cash and has more up for sale both there and the Gulf of Mexico. Add in some infrastructure assets it owns and might place into an MLP, and we believe ATP's upside dwarfs any potential losses.

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At the time of publication, Heiserman was long Chesapeake, ATP Oil & Gas and Contango Oil & Gas, although holdings can change at any time.

Hewitt Heiserman conceived the Earnings Power Chart and the Earnings Power Staircase. A graduate of Kenyon College with distinction in history, Heiserman is a member of the Boston Security Analyst Society and the CFA Institute. He also authored It's Earnings That Count. For additional information, please visit Earnings Power.

Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback; click here to send him an email.

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