Industrial Activity May Lift Natural Gas.........Stocks Further
By ERIN SCHULTE
THE WALL STREET JOURNAL ONLINE
The energy sector has lived up to its name in the past month, with the Dow Jones Pipelines index surging more than 19% during that time, making it one of the stock market's top-performing industries.
With a leap like that, investors may think the move in the group is done. But analysts believe the U.S. economic rebound and the ensuing increase in industrial production may drive the sector still higher.
The recent rebound comes after a grim post-Enron period. During that time, gas prices fell, accounting methods came under scrutiny and creditors tightened up on lending.
"They were so beaten up after the demise of Enron," said Mark Easterbrook, a senior analyst for RBC Capital Markets in Dallas. "You had the credit-rating agencies do an about-face in terms of what they thought was normal for these businesses, and a lot of them had to ... bring their balance sheets into order and improve their liquidity."
Among sector leaders, Williams Cos. has soared 59% from its 52-week low of $14.05, reached in early February. El Paso Corp. leapt 38% off its 52-week low in late January, and Western Gas Resources has surged more than 18% in the last month.
To be sure, concerns about some of the companies in the sector linger. Big energy companies have scrambled to refinance debt issued by affiliates that could require payment with the companies' stock, after the practices came under scrutiny from investors and credit-rating agencies.
While some investors remain jittery, sector analysts say they've become more comfortable with the industry's balance sheets.
Still, much of the recent surge in energy shares was fueled by investors who dove in for bargains. "In the longer term, these stocks are trading at absolute historical lows," Mr. Easterbrook said.
Yet bargain-hunting isn't the only thing fueling the sector's rise. Natural-gas prices are showing signs of life after languishing during the warmer-than-usual winter. After climbing above $10 per British thermal units last winter, natural-gas prices plummeted to about $2.35 earlier this month.
In recent weeks, natural-gas prices have started to nudge higher. Friday, natural-gas futures for April delivery opened at about $3.02 per 1,000 cubic feet.
While the warming of spring usually tamps down gas prices, the rebounding economy may help prices remain firm or even head higher.
"The weather's been so mild, but if you strip out the weather's impact on inventory withdrawal, you see that withdrawals have been pretty good," said Jay Saunders, a Deutsche Banc analyst. Mr. Saunders said he expects that the economic acceleration should push natural-gas prices to about $3.75 in the second half of the year, though he remains relatively bearish in the shorter term.
Moreover, the industrial sector, which accounts for more than a quarter of total U.S. natural-gas consumption, is starting to perk up.
On Friday, the Federal Reserve reported that industrial production surged in February, and January's decline was revised to show a small rise, snapping the manufacturing sector's extended slide of the last 1 1/2 years.
Last month's 0.4% rise in industrial production was the biggest since June 2000, and capacity use rose to the highest level since October of last year.
On the down side, there's more than enough natural gas on hand right now to meet increased demand. Natural-gas storage levels stand about 43% above their five-year average, according to the American Gas Association.
"With so much inventory, you'd think it would be pretty depressive for stock prices," said Allan Stewart, a managing director at Pira Energy Group. "But with the strength of the economy and the weakness in drilling, the optimism is there that gas prices will be higher."
Francois Trahan, equity strategist for Brown Brothers Harriman, said natural-gas rig counts are declining at the same time that demand is increasing. As of February, the number of drilling rigs exploring for oil and natural gas in North America sank 27% from the year earlier, to 825, according to Baker Hughes.
Less exploration and more demand ought to help bring down storage levels, supporting natural gas prices. Mr. Trahan sees higher prices in the next year.
But the draw down in storage is not happening as quickly as bulls would like. The American Gas Association said last week that 140 billion cubic feet was pulled from storage last week, a number that traders considered bearish and one that sparked natural-gas selling, though the withdrawal did come in at the high end of traders' expectations.
Merrill Lynch's Steven Fleishman likes diversified companies, like El Paso and Williams.
"El Paso has the greatest diversification of assets in the space, is experiencing the benefit of a clear flight to quality in merchant activity post-Enron and has the most leverage to the bullish natural-gas cycle," Mr. Fleishman wrote in a note to clients.
For the longer term, Mr. Fleishman likes Williams; Merrill Lynch set a year-end price target of $28 for its stock.
"Williams has moved to decisively shore up its balance sheet and address its liquidity concerns," Mr. Fleishman said. "As investor focus shifts from credit to earnings, we believe execution of its asset sales and new [energy market and trading] contracts could provide a summer sizzle."
Williams closed Friday at $22.38, well off its 52-week high of $43.71; year-over-year, its net income leapt nearly 75% in 2001. Its price-to-earnings ratio is 13.34.
Mr. Trahan of Brown Brothers names Devon Energy as a top natural-gas pick.
On Tuesday, Deutsche Banc upgraded Devon to "strong buy" from "buy." In February, the company beat earnings estimates, reporting quarterly operating earnings of 23 cents a share, versus First Call estimates of 11 cents. But its shares slipped when it reported, and its p/e ratio stands at a hefty 65.
Most analysts said exploration and production companies would see the biggest upside if energy prices keep rising.
"Their revenues and overall earnings are impacted by prices going higher, and so with gas prices going from $2 to $3 in the last six weeks, those companies should do better than anticipated just a month ago," Mr. Easterbrook said.
Phil Dow, director of equity strategy at Dain Rauscher Wessels, agreed that the E&P sector could be a top performer this year.
"Because of the economic recovery, demand for natural gas is going to go up," and unrest in the Middle East may cause companies to depend less on oil and more on gas this year, Mr. Dow said. He mentioned Apache, XTO Energy, Spinnaker Exploration and Pioneer Natural Resources as good opportunities.
One caveat: some analysts note that as the economic upswing becomes more sure and pronounced, investors may back out of the safe-haven energy sector, deflating prices, as they delve into riskier bets.
"You move away from safety once greed takes hold," Pira Energy's Mr. Stewart said. "These are outfits that generate cash. At the end of the day, they're proven to be safe havens."
Write to Erin Schulte at erin.schulte@wsj.com
Updated March 16, 2002 12:33 p.m. EST
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I stand corrected and retract my earlier comments about the stock going under $1. Natgas prices seem destined to end the summer quite strong, which should give more support to the BPR price than earlier contemplated.
I now believe it will bottom at around $1.50 or so. I've stopped dumping the stock and have decided (at least for now) to hold onto the rest of my position.