The Marcellus and Utica shale plays are two of the most promising and fastest growing gas-producing regions in the country. 

Utica Production Growth

Marcellus Production Boom

Source: EIA July Drilling Productivity Report

Estimates of how much gas is contained in these two formations are as high as 570 trillion cubic feet, over 50 trillion that are economically recoverable with today's technology and prices. Recently a report by Wood Mackenzie's analyst Jonathan Garrett predicted that the top 20 gas producers in the area will spend $110 billion through 2035 to unlock $90 billion in profits. Those profit figures may end up proving to be too conservative. According to Mr. Garrett, "If well costs continue to trend down and well results continues to trend up...I wouldn't be surprised if this number goes up a bit."

Poised to profit from the biggest gas boom in history

Consulting firm ICF International estimates that between 2007 and 2035 production from the Marcellus/Utica shale plays will increase 34-fold. Independent gas producers such as Range Resources (NYSE:RRC), Rice Energy (NYSE:RICE), Rex Energy (NASDAQ:REXX) Southwestern Energy (NYSE:SWN), EQT Corporation, (NYSE:EQT) and its midstream MLP EQT Midstream Partners (NYSE:EQM) are great ways for patient, long-term investors to profit handsomely from this historical gas boom.

RRC Total Return Price Chart
RRC Total Return Price data by YCharts

In the last few months stocks in these companies (except for Rice Energy and EQT Midstream) have faced immense pressure and fallen as much as 50% off their recent highs.

This drop is partially a response to a sharp decline in gas prices, which is a short-term event that now leaves investors with a potentially great opportunity to invest in one of the strongest energy megatrends in US history. 

Henry Hub Natural Gas Spot Price Chart
Henry Hub Natural Gas Spot Price data by YCharts

Let's look at the numbers

Company/MLP Historical Operating PE Current Operating PE Historical P/CF Current P/CF EV/EBITDA
Range Resources 28.2 44.3 9.5 12.2 17.25
Rice Energy NA NA 88.5 25.3 240.18
Rex Energy 20.6 24.5 13.1 5.4 9.13
EQT 23.1 31.6 11.6 10 10.28
EQT Midstream 32.3 30 18.5 25.1 37.58
Southwestern Energy 20.9 16.9 9.1 6.2 7.11

Sources: S&P Capital IQ, Yahoo! Finance

As this table illustrates most of these companies are trading at premiums to their historical operating earnings (I use operating earnings because of the capital intensive nature of the oil and gas industry can cause wild swings in EPS over short periods of time). However, on a price/cash flow basis, many of them are trading at significant historical discounts. This is largely due to continued fast growth in production and continued declines in well costs. For example, Rex Energy reported a 50% increase in quarterly production compared to a year ago and a 7% decline in drilling costs in its key Butler operating area over the first six months of the year. 

Southwestern Energy stands out as historically undervalued in terms of operating P/E, price/cash flow, and enterprise value/earnings before interest, taxes, depreciation, and amortization (a metric that takes into account cash, debt, and operating earnings). 

On the flip side, Range Resources, the largest operator in the Marcellus, is trading at a premium on all counts. However, as I'll now explain that doesn't necessarily make it a bad investment. 

Exceptional growth prospects

Company/MLP Yield 10 Year Projected Annual Earnings Growth 10 Year Projected Annual Dividend Growth 10 Year Projected Annual Total Return
Range Resources 0.20% 25.80% 19.58% 22.60%
Rice Energy 0% 70% NA 50.80%
Rex Energy 0% 55% NA 68.10%
EQT 0.13% 30% 22.58% 27.20%
EQT Midstream 2.40% 21.60% 21.28% 23.68%
SouthWestern Energy 0% 15% NA 15.10%
S&P 500 1.87%     9.20%

Sources: Fastgraphs, Yahoo! Finance, Moneychimp.com

All of the above companies are expected to crush the market's historical total return over the next decade, with the small caps Rice Energy and Rex Energy expected to deliver returns that would make them some of the best investments bar none. 

Southwestern's growth prospects, due to its already large size, explain why it's trading at low historical valuations; however, with a price to cash flow ratio of just 6.2 I believe it to be a solid long-term investment at today's prices. Similarly, Rex Energy and Rice Energy, given their enormous potential, represent excellent long-term investments as well. 

Range Resources seems more fairly valued, given its premium in all three metrics. However, I believe this premium can be justified, and it deserves at least a spot on your watch list. 

Paying up for quality

Range Resources Costs

Source: Range Resources Aug 18 Investor Presentation

Range Resources has proven to be a master at cutting costs, and as I explained in my last article, which examined its latest earnings miss, the company is firing on all cylinders and diversifying its transportation infrastructure providers, which will prevent earnings disappointments like the last one. 

Specifically, I continue to recommend Range Resources for three key reasons. 

First, the ability to cut costs as previously mentioned. Second, Range Resources has been able to grow its proven reserves by 28% annually over the last four years, to 8.2 trillion cubic feet of gas equivalent. With 65 to 86 trillion cubic feet of potential reserves, the company's proven reserve growth runway is long, and with 91% of its most profitable potential well locations still untapped, I fully expect management to achieve its ambitious growth targets. Which brings me to the final reason for buying Range Resources at today's prices.

Law of large numbers need not apply

Range Resources Long Term Growth Guidance

Source: Range Resources Aug 18 Investor Presentation

According to management, the company plans to triple their current production over the next three and a quarter years and continue to grow 20%-25% for several years after that. 

With a strong balance sheet (debt/EBITDA of just 2.4), no debt coming due until 2016, $1.1 billion available under its $2 billion credit revolver, and operating cash flows of $905 million per year, Range Resources has what it needs to continue growing reserves, production, and earnings at these target rates for many years to come. 

Foolish bottom line

The market's obsession with short-term factors is often a Fool's best friend because it provides an opportunity to pick up shares of exceptionally well run companies, with enormous growth prospects at undervalued prices. I believe this is the case with Range Resources, Rice Energy, Rex Energy, EQT, EQT Midstream Partners, and Southwestern Energy. These companies provide long-term investors with the opportunity to profit from the boom in the Marcellus/Utica shale plays at prices that make market-beating total returns likely for decades to come. 

Adam Galas has no position in any stocks mentioned. The Motley Fool recommends Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.