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Mid-Cap, Large Potential

Posted on: September 15, 2008 - Email Article - Printable Version

Mark Kinsella

About the Author:

I am not the first, nor the last, person to mention the sell off in commodities recently. Crude oil has now dropped below $100 a barrel and natural gas is down more than 40% off its twelve month high. No one can say when this slaughtering will stop and it is making more and more people wary of investing in stocks that are correlated with commodities. However, I have come across a company that has benefited from this rough time: Equitable Resources Inc [EQT: 35.96, +1.29 (+3.72%)]. A stock that has mirrored the movements of the sector as a whole over the last few months; Equitable is now cheap enough to bestrongly considered for a buy.

Company Description

Equitable Resources Inc. is an integrated energy company engaged in natural gas production, distribution, gathering and processing, transmission, and storage. It focuses in the Appalachian region, which is made up of parts of Pennsylvania, West Virginia, Ohio, Maryland, Kentucky, and Virginia. This region is one of the first places that natural gas was discovered in the 1800’s.

Equitable Resources is split into three segments: Equitable Production, Equitable Midstream, and Equitable Distribution. Equitable Production, formerly referred to as Equitable Supply, is the production business that produces and sells the natural gas. It generated 64% of the net operating revenue for Equitable Resources in 2007. Equitable Midstream and Equitable Distribution, which were formerly grouped together under Equitable Utilities, is the transportation, storage, and distribution of the natural gas. These segments generated the remaining 36% of revenue in 2007.

Financial Data

One of the key reasons I am attracted to Equitable Resources is its strong fundamentals and financial statements. In an extremely volatile industry that moves very similarly to the movement in the commodity market, it is not a surprise that Equitable’s stock price has taken such a hit in the last few months. It has moved almost identically to the Energy Select SPDR [XLE: 51.33, +1.18 (+2.35%)] year to date. This is why I see this as a great opportunity to get into Equitable Resoucres as it is extremely cheap and underpriced. Let’s take a look at some key financial highlights:

Market Capitalization - $5.42 billion
Beta - 0.92
Trailing P/E - 23.39x
2008E P/E - 20.55x
2009E P/E - 15.43x
Return on Equity (TTM) - 18.46%
Return on Investment (TTM) - 8.14%
Dividend Yield - 2.13%

The first number that I would like to highlight is the Trailing P/E of 23.39x. This number may appear to be a little high versus an industry average of only 7.89x, however, I feel that this number needs to be taken on a stand alone basis. Equitable Resources will not begin to reap the benefits of their expansion plans until later this year and 2009. This can be seen from the expected P/E’s of 2008 and 2009 at 20.55x and 15.43x, respectively. Return on Equity of 18.46% is extremely impressive versus an industry average of only 7.31%. Finally, Equitable’s Dividend Yield makes this stock even more attractive. In a market with very little stability, it is nice to be assured of some return on your investment. A high dividend will provide this security to people who are unsure where to look.

Looking Forward

Since Murry Gerber took over as the CEO in 1998, the company has had tremendous growth. He has taken on new projects and continues to look for new expansion opportunities. In September 2007, Equitable purchased an additional working interest of 13.5% in the Roaring Fork region in Virginia. This increases their control of that region to 97% and is expected to add an additional 12.3 Bcf of reserves. He plans to continue this growth into the future with $1.2 billion in planned capital expenditures for 2008. This is a 51.7% increase in CAPEX from 2007. About half of this is committed to drilling, as Equitable plans to drill up to 750 wells this year compared to 634 wells in 2007. On top of this, Equitable Resources plans to look into drilling in the Devonian and Marcellus shales. In terms of distribution, one can look for Equitable to continue expanding to other regions as the company grows. It is looking into potential opportunities to become a player in the Mid-Atlantic and Southeast markets. Mr. Gerber understands that this is the time to attack the natural gas market. A company that has quickly climbed the ranks in natural gas production in recent years, Equitable will clearly continue this growth in the future. As cheaply as it is priced now, it is ridiculous to ignore this stock.

Final Words

Obviously investing in any energy stock brings about many potential threats and concerns. The first risk and the one we encounter daily in stock market news is the price volatility of natural gas. Natural gas’s price directly affects Equitable’s revenue in the coming years. This is a tricky situation because it is impossible to determine which direction natural gas is headed (Charles Petredis does an impressive job addressing this situation in his article “The Bullish Case for Natural Gas”, so I will not bother regurgitating what he wrote here). To combat this, Equitable hedges by entering into long term contracts for large volumes of their natural gas production. Another major threat to Equitable, as with any natural gas company, is whether or not their wells yield the level of production that they are expecting. This will essentially determine how successful the company will be in the coming years and should always be considered before investing.

With all of that said, I think Equitable Resources is an extremely attractive play in the current market. It is impossible to say when the sell off in commodities will end and this stock will continue suffering as long as this is happening. Equitable is extremely cheap and even if it continues to suffer in the upcoming months, it will turn around with the rest of the commodity market. This is a great long term play as there is too much growth potential for Equitable to go anywhere except for up.

-Mark Kinsella

Disclosure: The author does not have any positions in EQT.

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