A new commodity cycle is approaching for energy stocks; leading the way in this momentum gauge is the Energy Select Sector SPDR Fund (NYSEARCA: XLE). The exchange-traded fund (ETF) outperformed the broader S&P 500 by 2% in the past quarter. While not much to speak of, this performance gap may show the beginning of a new trend that could last much longer.
Oil prices broke out – and stood comfortably – above their $79 a barrel ceiling. Now breaking above the $83 a barrel mark, predictions made by analysts at The Goldman Sachs Group Inc. (NYSE: GS) could come true. The investment bank thinks oil prices could go as high as $100 in 2024.
However, natural gas prices, which tend to follow oil prices, are now at a four-year low. This wide gap is counter to historic trends, and a catch-up in natural gas prices could make stocks like Natural Gas Services Group Inc. (NYSE: NGS) break out into new highs. Wall Street institutions see the opportunity, which starts here.
Once in a Cycle
Now that the Federal Reserve (the Fed) is considering cutting interest rates this year, money is getting ready to rotate. Because interest rates could be detrimental to the dollar index, commodities like gold and oil have started and amplified their rallies.
More than that, a weaker dollar could make American exports more attractive to foreign buyers, such as European nations and even Japan, as their currencies would become stronger relative to the dollar. Apart from being basic economic theory, there is actually a sound bit of evidence behind this trend.
In its 2024 macro outlook report, Goldman Sachs also mentions the expectation for a manufacturing sector breakout in the U.S. Export orders advanced by 6% in February's ISM manufacturing PMI index, the largest expansionary reading.
Natural gas is used as a raw material (feedstock) when manufacturing products like plastics and chemicals. The manufacturing industry as a whole is going to have to ramp up production to meet these export orders, making the natural gas trade a reality more than a thesis.
Natural Gas Services: The Momentum Replacement
Being a $242 million company has its perks. Smaller companies are often outside the purview – and buying power – of the significant funds and banks on Wall Street, where the retail investor can gain an advantage.
Not only that, quants at PGIM think that the ‘momentum trade’ is now overbought in large capitalization stocks, making small capitalization names the only place to squeeze further momentum in this cycle.
This thesis is at play for Natural Gas Services stock, as Barclays (NYSE: BCS) increased its position in the stock by 745% in the past quarter. As mentioned, the bank can’t take a significant stake in the stock as it would create unnecessary scrutiny. Still, a $360,000 investment in the company can be a vote of confidence.
Northern Trust Co. (NASDAQ: NTRS) and the Royal Bank of Canada (NYSE: RY) are other names that are buying the stock. Northern came in with a $470,000 investment, while the Royal Bank saw fit to have $150,000 in exposure to the stock.
The rest of the market is behind the stock’s prospects, as the following factors have been blown above the industry.
Decoding The Market’s Message for Natural Gas Services Stock
The Oil and Gas industry trades at an average forward price-to-earnings (forward P/E) ratio of 14.5x, placing Natural Gas Services stock at a 173% premium to its peers. “It must be expensive for a reason” is a saying that applies here; the stock is ‘expensive’ because of its future prospects.
Analysts think its earnings per share (EPS) can grow by as much as 182% in the next 12 months, significantly above the industry’s expected 47% growth rate this year.
Natural Gas Services provides the equipment necessary for companies like Kinder Morgan Inc. (NYSE: KMI) to operate their natural gas pipelines and processing facilities. This is why Natural Gas Services trades at 96% of its 52-week high while pushing out a 12-month performance of 92.4%.
As it is the first to get paid in anticipation of a rally in natural gas (which could mean more profits for Kinder Morgan), markets are willing to overpay today for the future EPS projections for the company.
When natural gas prices peaked in 2014, the stock reached $35 a share. Now that the fundamentals and economic tailwinds align to make a new ceiling a potential reality for the stock, history could repeat itself.