Many view natural gas as the fuel of the future. That's because it is such a flexible fuel as we can cook with it and heat our homes in the winter, use it to generate electricity or as a petrochemical feedstock and it can even be used as a transportation fuel. Moreover, it is abundant in the U.S., cheap to produce and cleaner burning than both coal and oil.
However, as bright as the future of natural gas might be it hasn't produced great returns for natural gas drillers. Many have seen their stocks fall as the price of natural gas plunged due to its abundance in the U.S. That being said, for investors that do see big things ahead, a small bet on a promising natural gas stock below $10 a share could yield big future rewards. I have three promising sub-$10 stocks on my radar that could be turn out into long-term winners. Yet -- and I can't stress this enough -- the reason these stocks trade so cheaply is because they are very risky and therefore come with a real binary outcome as the stocks could double just as easily as they could go to zero, in other words, buyer beware.
Fueled by the Marcellus and Utica
One of the great natural gas discoveries of the recent past has been the Marcellus and Utica shale plays in the Appalachian Basin region. Not only are these two shale plays absolutely loaded with natural gas, but they are also strategically located near the densely populated East Coast. That should provide producers like Magnum Hunter Resources (NYSE:MHR) and Rex Energy (NASDAQ:REXX) with enormous future growth opportunities.
The problem has been that when natural gas producers saw this gold mine of gas they pounced and created a huge gas rush. Magnum Hunter, Rex Energy, and other gas producers started drilling as many wells as they could, often borrowing vast sums of money to drill wells and acquire acreage. We see this in the following chart as the debt of both companies surged in recent years.
This debt fueled surge of activity created an enormous supply of gas, which has kept its price low and left these companies with a lot of debt and a single digit stock price. Now, both are working to invest within their cash flows in order to keep their head above water as they wait for gas prices to rebound. If that happens these stocks could surge, but if gas prices stay weak it could lead to years of underperformance or even bankruptcy due to the large debt loads both companies still have on their balance sheets.
Hanging its future on the Haynesville
EXCO Resources (NYSE:XCO), likewise, was caught up in the gas rush and like Rex and Magnum Hunter its downfall was debt. However, what's different is that EXCO used debt to extend its position in the Haynesville, instead of the Marcellus, as well as a shift toward oil by acquiring a position in the Eagle Ford Shale.
Still, this left the company with a bloated balance sheet, which it has been working hard to fix. As the following slide points out the company has steadily made progress in cutting its debt load, but still has a ways to go.
EXCO is currently working on a turnaround plan and recently took on a strategic partner to help it create value in the current market. If that partner and the company's new management team are successful in engineering a turnaround it could really boost the value of EXCO's single digit stock price. However, not all turnaround plans work and the risk remains that EXCO dug its own grave when it borrowed billions to fund growth at the top of the market.
Most stocks with a single digit stock price are priced that way for a reason -- investors are worried that those stocks could go to zero. That's certainly a risk with these three as a prolonged downturn in the natural gas market could send any one of them over the edge. That being said, if natural gas realizes its bright future and fuels new demand it could lead to higher prices for gas and these single digit natural gas stocks.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.