This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
If you spend your days tracking the ups and downs of the United States Natural Gas (NYSE:UNG) ETF, measuring the "premium" of price over net asset value, and charting the gap between oil and gas prices -- in short, if you are a natural gas investor -- then you'll want to listen closely today: Credit Suisse just downgraded one of the biggest names in gas.

According to Credit Suisse, natural gas prices have declined due to a glut of supply (the amount in storage recently hit a record high 3.59 trillion cubic feet) and a reversal in energy economics for electric plants, which makes coal more cost-effective than natural gas. The resulting decline in nat-gas demand pushes prices down even further. 

This year, Credit Suisse says natural gas prices will average $4.09 per million British thermal units. 2010 prices will rise to approximately $5.75, and longer term, Credit Suisse foresees natural gas costing about $7 -- which sounds good, but is actually about a 12% haircut off the prices Credit Suisse had predicted earlier.

As you can imagine, Credit Suisse argues that this is bad news for nat-gas explorer and producer Chesapeake Energy (NYSE:CHK), which:

• failed to lock in high prices on enough of its production when gas was at its peak;
• is today strapped for cash and burdened by debt that it's ill-equipped to service;
• and will therefore be hit hard if prices don't rise faster than Credit Suisse foresees.

Result: Credit Suisse downgraded Chesapeake to "underperform," essentially telling investors to sell the stock. Credit Suisse also recommended selling Devon Energy (NYSE:DVN).

Why should we care?
As you probably know, Credit Suisse is one of the biggest names in natural gas. This banker spends more time rating Oil, Gas and Consumable Fuels stocks than on any other sector -- but as I'm about to show you, bigger doesn't always mean better:

Over the course of the 74 recommendations Credit Suisse made in the oil and gas sector over the last three years, fewer than 50% are currently beating the market. My hunch is that this week's Chesapeake downgrade will follow that pattern -- and hurt investors who follow Credit Suisse's advice.

Facts are stubborn things
Why? Consider these facts.

According to its SEC filings, Chesapeake boasts 11.3 trillion cubic feet of proven natural gas reserves. Incidental to its flagship gas business, the company also possesses 120.6 million barrels of proven oil reserves -- equivalent to another 723.6 billion cubic feet of gas, if converted at the standard industry metric. That works out to about 12 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 1,030 Btus per foot cubed -- and right now, the Henry Hub spot price on these Btus is $3.24 per million Btus. So the value on these reserves works out to: 12 trillion cubic feet times 1,030, divided by 1 million, times $3.24, which equals $40 billion.

Yet the company itself carries an enterprise value of only $31.1 billion, roughly a 22% discount to the value of its assets. And if you look at NYMEX November contracts, which price natural gas at about $4.84 per million Btus, Chesapeake's resources are valued closer to $60 billion.

Did somebody say "bargain?"
Credit Suisse admits that natural gas prices will probably rise next year, and keep on rising to substantially higher levels over the next few years -- magnifying the size of the discount we see today. Yet somehow, Credit Suisse sees this as reason to sell the stock. I disagree.

I think Chesapeake's a buy.