Natural Gas stocks are getting attention from important Wall Street institutional buyers:

Gregg Greenberg

TheStreet.com
Thursday, Jul. 23, 2009 07:53AM EDT


Kent Croft, co-manager of the Croft Value Fund, says it's a good time to buy natural gas stocks.

The fund, which Morningstar rates four stars, has risen 16% this year, doubling the performance of the S&P 500 Index. The portfolio has declined 11% annually, on average, over the past three years, compared with a loss of 18% for the benchmark. He shares his views in TheStreet.com's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks in five fast and furious questions.

Are you bullish or bearish?

Croft: Overall, we are bullish. We think the market remains relatively cheap given the low interest-rate environment and current depressed earnings base. There is still a lot of cash on the sidelines, and we believe a good portion will enter the stock market throughout the rest of the year. This creates opportunities to do your research and find good long-term investments.

What is your favorite sector?

Croft: We like natural gas stocks, and believe this is a good time to build a position. We believe North American natural gas prices will trend higher over time due to growth in usage, political safety and its global strategic importance.

Over time, natural gas should trade at a price near its BTU (British thermal units) equivalency relative to oil, about 6:1. At today's prices the ratio is about 18:1; natural gas is trading at a 67% discount to oil on a BTU basis.

Electric power generation has gone from accounting for 19% of total natural gas demand 10 years ago to 31% in 2008. The vast majority of new power generation is natural gas fired and will continue to drive natural gas usage. Natural gas fired power plants emit 40% less carbon dioxide per BTU versus coal-fired plants. Any greenhouse gas legislation that puts a price on emissions would make natural gas more attractive.

As of mid-May, the Baker Hughes gas rig count stood at 728, down 55% from the peak in mid-2008. We expect supply to decline as natural production declines are not replaced. In 2006, 30,000 wells were drilled compared to less than 10,000 wells per year in the 1990s. Production remained flat over the period.

A rebound in the broader economy would increase demand for natural gas used in industrial applications and electric power generation, which could create a supply crunch if the rig count remains at the currently depressed level.

What is your top stock pick?

Croft: Our top pick would be Southwestern Energy(SWN-N41.59-0.87-2.05%). Southwestern is developing its 875,000 net acre position in the Fayetteville Shale in Arkansas. We expect Southwestern to increase production and reserves by 40% in 2009 and 25% per year over the next five years. We estimate that Southwestern may ultimately recover 13 trillion cubic feet of natural gas from the Fayetteville Shale, six times the company's 2008 proven reserves.

What is your favorite "sleeper" stock pick?

Croft: General Cable(BGC-N41.45-0.56-1.33%) is a leading manufacturer of copper, aluminum and fiber-optic cable for electric utility, communications, and industrial and specialty markets. General Cable is the largest domestic producer of electric utility cables and one of the largest producers of outside plant telecom cables in the U.S. Along with providing cable for the alternative energy expansion, General Cable should also benefit from the upgrade of the grid.

Until 2006, investment in the U.S. electric transmission and distribution grid had been in decline for 30 years. One million miles of the grid's 2.2 million miles was constructed between 1948 and 1970. This equipment has a 40- to 50-year life, and has been failing increasingly since the start of the decade, the worst failure being the massive blackout in August 2004. The Energy Act of 2005 made changes to the current policy, which is favorable to grid spending.

We expect General Cable to grow earnings per share in the teens over the next three to five years. We believe the shares are attractively valued today at 10.3 times estimated 2010 earnings.

What sector, industry or stock would you avoid?

Croft: We would avoid the specialty retail and high-end retail sectors. It could take time for the consumer to return to a more aggressive spending habit. The higher-end products and specialty areas could feel that for some time.