3 Natural Gas Companies Beating the Street

Even at the choicest poker tables, with the highest stakes running; players vie for the winnings through an ever-dynamic mix of skill and luck.

For the following three natural gas producers to each outperform prevailing expectations with solid first-quarter earnings, a similar mix was required.

Luck of the draw
Devon Energy (NYSE: DVN  ) used both skill and luck to lay down the most impressive hand in the group. With the ink barely dry on Devon's aggressive dealmaking to shed U.S. offshore assets in the Gulf of Mexico, all manner of pain has befallen the remaining Gulf operators following the disastrous explosion and sinking of a rig working for BP (NYSE: BP  ) . Converting those offshore assets into pre-tax cash of $9.9 billion to fast-track an aggressive restructuring into the onshore space exhibits skillful maneuvering by Devon, but the accidentally fortuitous timing was purely the luck of the draw.

While BP clearly has all hands on deck to remediate this environmental catastrophe, another major buyer of Devon's assets in the gulf has indicated it will proceed with plans to develop its now-wholly owned Cascade-Chinook play. Referring to its decision to develop the offshore field, Brazil's Petrobras (NYSE: PBR  ) indicated: "It's common to revisit procedures once we know what happened and the investigation is complete. It's too early to say we will change anything."

Meanwhile, just as my Foolish colleague Toby Shute predicted, Devon is deploying the mammoth windfall generated by these asset sales both to shore-up its balance sheet, and to improve shareholder equity with an impressive $3.5 billion share-repurchasing initiative. For Fools counting cards, that equates to roughly 12% of the company's market capitalization. I believe that Chairman and CEO J. Larry Nichols accurately conveys the strategic position of the newly restructured Devon Energy when he states:

Devon is emerging with a rock-solid balance sheet, a balanced portfolio of oil and gas projects and one of the lowest cost structures in the peer group. This positions the company to deliver low-risk, profitable, organic production growth on a sustainable basis.

Back on the skill side of the equation, Devon yielded a separate pre-tax windfall of $524 million from successful hedging, and reports a near-100% success rate on the 454 wells the company drilled during the quarter. Also, with a product mix that was weighted only 68% in natural gas -- at a time when natural gas producers are scrambling to increase their exposure to oil and natural gas liquids -- here again I view Devon Energy as the real deal among North American energy plays.

Producers pass (on) gas
With natural gas prices languishing in relative weakness amid a persistently elevated supply, producers are increasingly looking to enhance profitability through a greater focus upon oil and natural gas liquids within their overall product mix. As Chesapeake Energy (NYSE: CHK  ) CEO Aubrey McClendon explains: "That's where the money is these days with oil-to-gas values now exceeding three to one." Sandridge Energy (NYSE: SD  ) recently revealed that oil production is 10 times more profitable than gas.

Reflecting this emerging focus upon optimization of liquids production, Chesapeake has indicated a desire to reduce its excessive natural gas weighting to a more balanced 80% of total production. Looking to the first quarter data, we find Chesapeake achieving half of that target, with liquids accounting for 10% of average daily production. Accordingly, natural gas production rose only 7% year over year, while liquids flowed into 35% more volume. To move closer to that 80/20-mix, Chesapeake will reduce its peak 2010 rig count by 12% to 105 rigs, and institute an even sharper curbing of effort in 2011 with a 17% reduction in gas-related capital expenditures.

For a company that nearly crumbled beneath the weight of weak gas prices not that long ago, a more diversified product mix will come as a welcome improvement.

So long, ex-XTO
In likely our last glimpse of XTO Energy (NYSE: XTO  ) before it is subsumed into the giant fold of ExxonMobil (NYSE: XOM  ) , we find production of natural gas liquids increasing 9% year-over-year to help alleviate the impact of a 2% decline in oil volumes. Overall, revenue slipped 7% despite a 6% increase in production. Nonetheless, as with Devon and Chesapeake above, XTO's 32% earnings decline sufficed to surprise analysts with adjusted profit that was 15% ahead of Wall Street's average estimates. Sporting a first-quarter product mix featuring 17% of production in liquids, Exxon swallows XTO's natural gas exposure with a tasty liquids chaser.

So there you have it, Fools: Three natural gas producers that beat the street despite persistent weakness in the market for their primary product. Chalk it up to whatever combination of skill and luck that you will, but these operators prove that some players can win a pot regardless of the hand they are dealt. Of the three, Devon Energy appears to be holding the clear upper hand, but I look forward to hearing your thoughts in the comments section below.

The "natural gas" tag within the Foolish universe of Motley Fool CAPS lists 58 ways to invest in the space. Join the CAPS community to discover which gas plays burn brightest. It's free and fun!

Chesapeake Energy is a Motley Fool Inside Value selection. Petroleo Brasileiro is a Motley Fool Income Investor recommendation. The Fool owns shares of Chesapeake Energy, Devon Energy, and XTO Energy. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns no shares in the companies mentioned. The Motley Fool has a highly liquid disclosure policy.


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