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Natural gas is going to be the next show stealer. It's understandable that investors are excited and want to start early and get hold of a handful of natural gas stocks. But Fools must also be aware of pitfalls. Let's see how Southwestern Energy (NYSE: SWN ) is stacking up as a new-age natural gas play.
This Houston-based company has been riding on impressive returns, thanks to increased production over the past few years. Its Fayetteville shale operations in Arkansas produced 350.2 billion cubic feet (Bcf) of natural gas in 2010 -- a 44% jump from 2009 and a whopping 160% jump from 2008.
Not surprisingly, this has reflected well on earnings before interests, taxes, depreciation, and amortization (EBITDA), a metric that shows the returns from core operations.
For Southwestern, five-year compounded annual growth rate of EBITDA stands at an impressive 32.7%. For Ultra Petroleum (NYSE: UPL ) , the corresponding value stands at 12.6%; for Chesapeake Energy (NYSE: CHK ) it stands at -4.2%; Range Resources (NYSE: RRC ) stands at 4.3%, while GMX Resources (NYSE: GMXR ) comes in at 28.8%. Southwestern is clearly doing something right.
Ace up the sleeve
Proved reserves showed a jump to 4,937 Bcfe at the end of 2010, from 3,657 Bcfe a year before. That's a 35% jump. The increase is again primarily due to development of the Fayetteville shale play. There is huge scope for increase in production. In fact, it's estimated that these extensions and new discoveries will contribute $1.2 billion in future net cash flows.
The total present value of estimated future cash inflows from proved reserves, less future development and production costs, discounted at 10% per annum, stands at $3.0 billion as of Dec. 31, 2010. That's a massive jump from $1.8 billion a year before.
How is the stock valued?
How expensive is Southwestern when compared against future cash flows? Total enterprise value/discounted future cash flows (TEV/DFCF) comes to 5.45. For Ultra Petroleum the value stands at 2.56, while for Chesapeake it stands at 2.39. For Range Resources and GMX Resources, the value stands at 3.20 and 2.17, respectively. So, Southwestern looks expensive; you're paying up for that growth.
The current valuation of the stock also appears expensive. The trailing-12-month price-to-earnings (P/E) ratio stands at 24.84, compared to Ultra Petroleum at 16.36 and Chesapeake at 13.34. But I believe there is a rationale behind the market pricing this stock higher.
Historically, the stock has done extremely well. Five-year stock returns stand at 108%, compared to 12% by the S&P 500 Index and 49% by the Dow Jones U.S. E&P. Future cash flows look promising as well. It's not too late to grab a few Southwestern shares.
The Foolish bottom line
With a rising demand for natural gas, I believe the story will only get better for Southwestern. In all, investors have a stock that looks promising. While it may appear slightly overvalued, the growth prospects look comparatively better. Foolish investors won't be disappointed.