Description

Petroleum Development Corporation (PETD) is a regional independent energy company engaged primarily in the development, production and marketing of natural gas.

Natural gas is an industry with a great short term and long term outlook for investors. Demand for natural gas has been increasing by 3% per year, and demand is expected to increase even more in the future. Because it is environmentally friendly, natural gas is now the preferred energy source for new electricity generating plants. Demand is increasing faster than supply because wells get depleted; new wells haven’t been drilled fast enough to keep up with increased demand.

Oil prices are up this year, and natural gas is somewhat tied to the price of oil. Some users of energy have the choice to substitute natural gas when oil prices are up. I believe that oil prices will not go back down to the low levels of recent years, because as with natural gas, demand is increasing faster than supply (and in the long run, supply will fall because fossil fuels are a limited resource that we are slowly depleting).

The above factors have led to higher natural gas prices this year than have been seen for a long time.

PETD is my best pick amongst natural gas producers. Although priced like a value stock, PETD is really a growth stock! Annual net production of natural gas has increased from 1,336 MMcf in 1995 to 3,451 MMcf in 1999. On a per share basis, this is an increase from 0.12 Mcf/share to 0.21 Mcf/share. This is an annualized increase of 15% per year.

Besides production, the other major source of revenue for PETD is drilling revenue. Drilling revenue is up from $13.9 million in 1995 to $42.1 million in 1999. On a per share basis, that is an increase from $1.20/share to $2.59/share. This is an annualized increase of 21% per year. Continued high prices of natural gas will lead to continued high drilling revenues.

Earnings per share have increased even more, from a mere $0.13/share in 1995 to $0.48 in 1999.

Things will get even better for PETD in 2000. First quarter diluted earnings increased from $0.16/share in 1999 to $0.20 in 2000. The company has already announced that production for the first half of the year is up 83% from the previous year.

Increased natural gas prices have not yet fully showed up in PETD’s earnings results because PETD made the unfortunate mistake of hedging at a price lower than current prices. Through the October, 90% of PETD’s production is hedged at $2.88/MMbtu (1 MMbtu = 1.03 Mcf of natural gas). Then from November to March, 63% of production is hedged at $3.39/MMbtu. By comparison, average selling price in 1999 and 1998 was only about $2.39/MMbtu.

As you can see, based upon increasing production and higher prices for natural gas, it is practically guaranteed that PETD will be reporting huge earnings increases over the next few quarters.

PETD has a conservative balance sheet. PETD’s has assets of 119.4 million with liabilities of only 45.2 million. Book value per share is $4.64. At PETD’s current share price, the price/book value ratio is lower than most other companies in the industry. But the asset value of a natural gas company is best based on proven reserves rather than accounting book value. PETD reported proven reserves of 101 Bcf in its last 10K. Based on 16 million shares outstanding, that’s 6.31 Mcf/share.

Despite PETD’s great past performance and bright future, the stock was trading today at only 5 1/4. Based on trailing 12 month earnings of $0.52/share, that gives PETD the low PE ratio of 10.2. Yes, you could find a stock with a lower PE ration, but PETD has a track record of continuous growth, and PETD is in the natural gas industry which has a very good short term and long term outlook. I would buy now, before earnings are released in early August.

Catalyst

As a small company, PETD is ripe for being bought out by a larger energy company. Higher natural gas prices will likely lead to industry consolidations. Big companies will find it easier to increase production by buying out a smaller company than by drilling new wells. PETD’s low share price makes it a likely target.

The other catalyst is continuing high natural gas prices. Eventually, Wall Street will notice that PETD is trading at such a low price relative to its intrinsic value. I expect stocks of all energy companies to perform well in the short term, because Wall Street will soon realize that energy prices are higher and staying there.