This article is part of our Rising Star Portfolios series.
Last month, I invested more than $2,000 in a basket of energy stocks for my Motley Fool real-money portfolio. You can read the article here and check out how the stocks have fared since my recommendation. Today, I'm not straying too far from that original thesis, although instead of focusing on oil, I'm focusing on natural gas and the potential rally that's waiting ahead of us.
Not "if," but "when"
Commodity prices for everything from food to metals have been skyrocketing lately, and investors that have been riding the wave have surely benefited. However, one commodity that has stayed relatively flat has been natural gas. A combination of pretty weak demand coupled with frantic drilling from exploration and production companies has kept prices down. Cash-rich oil conglomerates like ExxonMobil (NYSE: XOM ) and Chevron (NYSE: CVX ) have been forming joint ventures and acquiring smaller gas companies in anticipation of a nascent recovery in natural gas. Even BP (NYSE: BP ) , attempting the first in what will most likely be a number of moves in its recovery from the gulf spill last year, has gotten in the game -- it recently announced a $7.2 billion move into difficult natural gas blocks in India.
Both ExxonMobil and BP recently released independent reports that confirm the same feeling: Natural gas is going to surge; it's not "if," but "when." While oil demand is expected to rise by 0.6% annually, natural gas is supposed to surge by 2.1% each year for the next 20 years. Want to get in on the rally? I've got one company worth your while.
Range Resources (NYSE: RRC ) is a $7.7 billion exploration and production company that has been led by Chairman and CEO John Pinkerton since 1992. It drilled its first wells in the Marcellus Shale in 2004 and has an extremely beneficial first-mover advantage in that area, well considered one of the best low-cost natural gas plays in the entire U.S. The company holds nearly 1 million highly prospective acres under long-term, cheap leases, which should help push production growth over the next 10-plus years. Align that with its legacy positions in the Barnett Shale and Nora Field and you've got a company that is poised for growth for quite some time. In fact, it recently purchased 115,000 acres from Chesapeake Energy (NYSE: CHK ) , bringing its total to 350,000 in that region.
And the proof really is in the pudding. The company recently reported year-end reserves of 4.4 trillion cubic feet equivalent, a 42% increase from the year before. Range has been able to increase its production growth for 32 straight quarters, and management believes the company's existing asset base has the potential to grow proven reserves by 8 to 10 times.
Risks and valuation
Of course the biggest risk to buying Range Resources is a prolonged slump in natural gas prices, which would obviously depress profits and slow down development projects. There are also regulatory and environmental concerns, most specifically the possibility of a Pennsylvania state severance tax that could go into effect early this year. Furthermore, while Range so far has proved to be a savvy capital allocator willing to sell assets and avoid share dilution, a disruption in the marketplace could force Range to issue equity or sell potential acreage to fund its current operations.
Using a forward 2012 enterprise value/EBITDA of about 9 times earnings, you get a value for Range of nearly $86 per share, which represents an amazing 80% upside potential. Of course with all oil and gas companies, this is more of an art than a science, so I wouldn't be surprised if the price ended up falling somewhere in the $75-$85 range; however, that would still make me one happy investor!
The Foolish bottom line
Range has illustrated that it's more than just adept at allocating capital, since it has sold close to $1 billion worth of properties since 2007 in order to redirect cash toward more promising opportunities. Management has proven very savvy, and its early foray into the Marcellus shale puts it in a great position that honestly would be pretty hard to screw up. And to top it off, management believes in what it's doing -- Pinkerton is the largest individual shareholder, controlling more than 2 million shares, while other top executives control an additional one million shares.
If you're looking to get into natural gas before it becomes the next trend, then Range Resources is a perfect way to play. Feel free to add Range Resources to My Watchlist and get the most recent analysis and commentary!
This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).