Rocket Stock or Dud?

"The bigger they are, the harder they fall." It's the worst nightmare of every investor in today's market -- buying a rocket stock just before it takes a nosedive.

Now I readily admit that sometimes, stocks rise for a reason. But sometimes, the rise becomes the reason. No matter how often we caution them not to, investors do have a habit of buying "hot" stocks, and trusting momentum to keep 'em moving upwards.

Problem is, if the price goes up too much, even a great company can turn into a lousy investment. Below I list a few stocks that may have done just that. Stocks that, according to the smart folks at finviz.com, have more than doubled since the beginning of this year, and just might be ripe to fall back to earth.

Stock

Recent Price

CAPS Rating
(out of 5)

Atlas Energy Resources  (NYSE: ATN  )

$25.10

*****

AK Steel  (NYSE: AKS  )

$20.33

***

Cree Inc (Nasdaq: CREE  )

$37.44

***

Tenet Healthcare  (NYSE: THC  )

$4.81

**

Dendreon  (Nasdaq: DNDN  )

$23.80

**

Companies are selected by screening for 100% and higher price appreciation year-to-date on finviz.com. Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Each of these stocks has enjoyed remarkable gains this year. But if you ask the 140,000 investors (and counting) who occupy the judges' stands on Motley Fool CAPS, it's time to get out while the getting's still good. Four of the five receive marks far below average, and just one stock on this list -- the stock we'll be profiling today -- gets the full five-star treatment.

But I've got my own suspicions as to why Atlas Energy might blow up on investors; before I explain my objections to the stock, let's give the bulls a chance to state their case:

The bull case for Atlas Energy Resources 
Two months ago CAPS member bobutrup called Atlas "[o]ne of the best shale drillers around. Shift toward nat gas in the near future, away from other dirtier carbon fuels will always help." jdiazmunoz agrees: "The drive toward clean energy consumption will drive sales of this efficient natural gas producer, while gas prices will likely increase from their current depressed levels as economic recovery takes hold."

In April, CAPS All-Star kkotwani predicted that over the "next 10 to 15 years focus will shift from oil to natural gas. Mainly because available in plenty in North America," which is a "Top priority in Obama's to do list till we come up with complete renewable solution. After exhaustive search on Natural Gas stocks, this is the only one which caught my attention." kkotwani was especially impressed with the firm's "strong growth in sales (36%) and income (15%), even during worst times of economy where most of companies are showing losses."

OK, so we've got a strong macro thesis underlying Atlas shares. But what about the valuation? Now that the stock's already doubled since the start of the year, is there any room for it to rise further?

Short answer: No
Here's why not. At last report, Atlas boasted roughly 991 billion cubic feet of proven natural gas reserves. Incidental to its flagship gas business, the firm also has about 1.7 million barrels of proven oil reserves -- equivalent to about 10.2 billion cubic feet if converted at the standard industry metric. So call it 1 trillion cubic feet-equivalent.

Now traditionally, natural gas is priced in terms not of "cubic feet," but of the BTUs produced by burning these "cubic feet" -- roughly 1030 BTUs per foot cubed -- and right now, the spot price on these BTUs is $2.25 per million BTUs. So the value on these reserves works out to $2.3 billion (1 trillion cubic feet times 1030, divided by 1 million, times $2.25).

Meanwhile, Atlas itself carries an enterprise value of just $2.5 billion. Compare AtlasAtlas to a rival like Chesapeake Energy (NYSE: CHK  ) , which has 12 trillion cubic feet of gas and equivalent oil reserves, and you'll find a similar disconnect -- Chesapeake's reserves are "worth" $27.8 billion; the enterprise values comes in at $27.7 billion. Where's the margin of safety?

Sure, the overvaluation evident in natural gas stocks makes even the crazy price-to-net asset ratio of a nat-gas ETF like United Natural Gas (NYSE: UNG  ) look better. But "less overpriced" ain't the same thing as "cheap," folks.

Foolish takeaway
Across the nat-gas industry, companies are selling for prices significantly higher than their worth. Now, maybe this portends a surge in prices in the near future, maybe not. I'm no commodities expert -- which is why I don't buy the stocks, myself. I know my limitations.

But one thing I'm certain of: Natural gas prices had better rise, and quick. Because right now, investors are taking a price rise for granted. If it doesn't happen, there's bound to be some pain coming investors' way.

Disagree? Feel free. Click on over to Motley Fool CAPS and sound off.

Chesapeake Energy is a Motley Fool Inside Value recommendation, and the Fool owns shares of it.

Fool contributor Rich Smith does not own shares of any company named above.You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 491 out of more than 140,000 members. The Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (26)

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  • Report this Comment On September 08, 2009, at 12:56 PM, UltraContrarian wrote:

    It's nice to see a skeptical view on TMF since Chris B, Toby S and a few others really dominate the commodities discussion. They proved last spring and summer that they were not so good at valuation - in fact, some commodity bulls admit they don't even care about it.

  • Report this Comment On September 08, 2009, at 2:42 PM, Nrgyindependance wrote:

    Ah yes ---- but the writer has not stated that ATN has hedged large portions of their gas sales for several years out at $7 to $9 per MMSCF. This looks like profits to me! He also has neglected to mention the nice dividend which has been suspended pending merger with Atlas America (not sure if it will be re-instituted). The cash flow had been more than enough to pay the dividend. This merger is the one thing that has me confused --- not sure how it benefits the ATN shareholder.

  • Report this Comment On September 11, 2009, at 11:11 AM, LAVol wrote:

    The author's analysis is faulty. He values the reserves at TODAY's gas price. Objectively, he should value the company at future gas prices (Mark to market). Furthermore, if ATN has a high % of their gas production hedged for several years, then the risk to the company's value is minimal. The only "fear" I have is that ATN will get pulled down with other Natgas stocks when prices deteriorate further in the next few months, which, based on history, will happen.

  • Report this Comment On September 11, 2009, at 9:06 PM, ValuePEG wrote:

    As previously stated the author grossly miscalculated his valuation of ATN by not using current futures pricing & accounting for extensive hedging, but the 5 points that everyone missed are:

    #1 - Location-Location-Location ATN's reserves are located in the North-East where they routinely receive about 6% premium over market because of local demand.

    #2 - BTU count is actually about 3% higher than quoted as reported in conference calls.

    #3 - Upside from future exploration of current properties, the Marcellus region has only begun to be explored the company has stated that there is the potential of 9 Tcfe in that region alone.

    #4- ATN natural gas resources are primarily dry-gas which require no processing, and significantly reduces the costs associated with production, I believe ATN's cost are less than 1/2 of CHK's and thats why ATN is accelerating production and CHK is shutting in production (and you wonder why ATN is receiving a premium to CHK, duh)

    #5 - The merger of ATN & ATLS essentially here is how they want it to play out :

    1st - All dividends will be re-invested internally in horizontal drilling in the Marcellus region - that means 100% W.I. instead of 30% W.I. through current investment programs.

    2nd - The $74 million in cash ATLS is sitting on will immediately accelerate growth in Marcellus region. The company is estimating doubling production in this region through 2010, which would increase company-wide production by 50% in 2010.

    3rd- The millions of shares of AHD & APL which will be essentially free to ATN shareholders, along with the G.P. & Management Incentives on ATN (actual cost 3.87% of representation in company on a per share basis). The company has already stated a desire to spin-off the pipeline business in its entirety after the merger is consummated.

    ---In summary the merger is to withhold dividends and focus the vast majority of cash-flow into the Marcellus on company owned projects, yes investors will lose a great dividend but in turn they will receive a company with much faster growth potential and higher ROE because they wont be giving away 70% of profit (not to mention protect their . As the company has stated the new company will have greater access to capitol and institutional investment since it will not be a L.L.C.

    I apologize for the length of my response, but I hope this clears up a lot of issues.

    Disclosure I hold shares of ATN, as well as other Oil/Gas investments for complete listing check:

    http://caps.fool.com/player/valuepeg.aspx

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