If you’re unimpressed by the recent earnings reports in the energy sector, you’re not alone.Natural gas companies in particular have reported less-than-stellar earnings over the past couple of weeks.
With gas prices declining – along with stagnant overall demand and increasing supplies – companies like Chesapeake (NYSE:CHK), Devon (NYSE:DVN), and Encana (NYSE:ECA) just weren’t able to generate killer profits. As a result, all three companies are well off their 52-week highs achieved earlier this year.
Don’t give up hope just yet, though. There’s still an opportunity to scoop up some short-term gains with these stocks.
Taking Evasive Action
The price of natural gas dropped in the second quarter and averaged in the low $4s per thousand cubic feet (mcf), which just isn’t high enough for these companies to turn a decent profit. Prices need to be at least at the $5-per-mcf level for the big bucks to kick in, yet with gas prices now sitting in the $3s, the third quarter promises to look even worse.
But that doesn’t mean these companies are doomed. Far from it.
These firms are taking action to strengthen their futures after a major debt binge in the last decade. And they have huge assets on their books, which they’re selling to free up cash.
For example, Devon received over $2.8 billion from the sale of non-core assets in the second quarter. Chesapeake has been selling billions of dollars’ worth of property to deleverage its balance sheet – leaving the company with the most prolific producing properties in areas like the Marcellus Shale and the Permian Basin.
These companies are also shifting production from natural gas to liquids. (It’s an easy shift back when natural gas prices head higher.) Devon is now projecting that liquids will account for close to 60% of its production by the end of the year.
Natural gas liquids deliver much higher margin, so we should actually start to see profits move higher in the third and fourth quarters (as far as year-over-year comparisons are concerned).
Chesapeake has a long way to go in this regard. While revenue increased significantly year over year, the company’s business is still tilted towards natural gas instead of liquids. This means it saw lower margins than Devon this quarter.
At the same time, however, that’s also where the future opportunity lies for CHK. As it continues to shift production to liquids, we should start seeing higher margins going forward.
Will this be enough to compensate for slowing growth in the industry overall, though?
Has the Energy Story Stalled?
The growth in the energy market that was beginning to take hold in Europe has stalled. And events in the Middle East and Russia are putting a damper on growth prospects in those regions. That leaves the United States, China, and India to pick up the slack in terms of energy demand.
Yet while China and India look to be increasing demand, the United States is actually seeing flat demand for oil – even while the economy is humming. Still, given the actions the companies above are taking, I’m convinced that even dismal third and fourth quarters may offer a chance to buy into some good names that have stupendous long-term potential.
And “the chase” continues.