Gheit: Natural Gas Stocks Due for a Pullback

[Stocks-to-Watch]

In a note out today entitled “Gas Indigestion,” Oppenheimer analyst Fadel Gheit says that natural gas producers have risen even though the commodity price has dropped, and are due for a 10% correction.

Since the start of the year, West Texas crude oil has risen more than 7%, but natural gas prices are down 10%. In the past few years, natural gas prices and oil prices have diverged considerably. With gas supply still outpacing demand, and oil prices boosted by continuing unrest in the Middle East, Gheit expects the commodities to continue on their separate paths. Natural gas now trades at 75% the price of crude on an energy equivalent basis, two to three times as much as the average historical discount.

Domestic natural gas company stocks are trading at 20 times expected 2011 earnings and 7 times expected cash flow, which Gheit considers “too optimistic,” particularly given the likelihood of another drop in gas prices. Most natural gas stocks are up more than 10% this year. Chesapeake Energy (CHK) has risen 36%; Devon Energy (DVN) is up 16%.

“While we expect crude prices to remain inflated and could go higher depending on which regime falls next, we expect natural gas prices to fall further in the next two months on typically low seasonal demand. We think the broad gains in the stocks of domestic natural gas producers cannot be justified on valuations or industry fundamentals and, therefore, we expect a 10% correction.”

Original Article Source by Barrons.com