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XTO Marks the Spot


Natural gas producer shows promise.

"When I drive that slow, you know it's hard to steer
And I can't get my car out of second gear
What used to take two hours now takes all day
It took me 16 hours to get to L.A."

- I Can't Drive 55 (Sammy Hagar)

Arguably the biggest hit of his solo career, I Can't Drive 55 was Sammy's not-so-subtle protest of lowering speed limits on highways. Say what you want about Sammy as an artist – he certainly had a point, and the song still gets massive radio play. Back then, I don't think anyone thought about cars being powered by anything but gasoline. Today fossil fuels have taken on a whole new meaning.

Yesterday we talked about Peak Oil theory and looked for a trading opportunity in Schlumberger (SLB). T. Boone Pickens, the legendary energy investor, is a proponent of the theory and one of his many solutions includes natural gas.

In 1997 he formed Pickens Fuel Corporation and heralded natural gas as the best fuel alternative, saying:

"It's a domestic resource that is clean as natural gas vehicles emit about 95% less pollution then gasoline powered vehicles, and it something that we have a lot of here in the United States, reducing our dependency on foreign oil."

The firm was reincorporated as Clean Energy (CLNE) in 2001. It now owns and operates natural gas fueling stations all over North America. As prices for gasoline continue to make a base around $3 per gallon, the spotlight on natural gas shines ever brighter.

XTO Energy (XTO), according to its website, "is a premier independent domestic producer engaged in the acquisition, exploitation and high-quality, long-lived produc[tion] [of[ natural gas and oil properties."

On February 12th, after reporting fourth quarter earnings, XTO Energy announced that its oil and gas reserves as of year end were at a record 11.29 trillion cubic feet of gas equivalent, up 32% year over year, and that natural gas reserves were 9.44 trillion cubic feet, up 36% year over year. It went on to target 15 trillion cubic feet of gas equivalent of proved reserves by the end of 2009.

XTO Energy also has a very strong management team. Bob R. Simpson, one of the company's co-founders, serves as Chairman of the Board and Chief Executive Officer. On February 25th, Mr. Simpson gave one of the better CEO interviews in recent memory on Jim Cramer's Mad Money. And unlike many corporations, management at XTO Energy puts its money where its mouth is, owning more than 6% of the company's stock.

The above due diligence could be reason enough to race out and buy the stock, but sometimes all we have to do is look for a "tell." In poker, a tell can be defined as a detectable change in a player's behavior or demeanor that gives clues to that player's assessment of their hand.

In trading, a tell often occurs from observing the price action of the stock (or any other trading vehicle) after an event. In the case of XTO Energy, the tell came on February 14th after they priced a 20 million share secondary at $55.00 through Goldman Sachs (GS), JP Morgan (JPM) and Lehman Brothers (LEH). The market gobbled up that offering, and by March 3rd XTO Energy made a 52-week high of $64.00. Not a bad return over a 12-day trading period.

At 17.00 times trailing and forward earnings, there are some that would argue that the firm's getting a tad rich on a valuation basis. But since its IPO in 1993, XTO Energy has consistently grown into its valuation and I don't see that trend ending anytime soon. On February 27th, Jefferies Group (JEF) raised its price target on XTO Energy to $73 from $58.40, citing 2009 reserve guidance.

I love both the space and the price action of XTO Energy. Around the current level of $61.00, I think we can enter into a long position. I'd worry if we traded through the $55 level that the secondary offering was priced at. On the upside, anything north of $64 is an all-time high and I believe we could see a $70 handle on this stock by the summer.

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No positions in stocks mentioned.

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