In the ongoing debate about the viability of different energy sources, a lot of focus has shifted to the natural gas sector (diversified/utility). The commodity has shown several progressive steps to becoming a “bridge” fuel, or a fuel that serves as a transition from oils to renewable energy. To this end, we have decided to shed a little light on this often neglected sector.

The overall natural gas industry has undergone a number of changes in the past few decades, especially since the mid 1980’s, with the easing of several regulations that inhibited growth. One of the primary differences in the landscape is the rise of natural gas marketers, which facilitate the movement of natural gas from the producer to the end user, offering either bundled or unbundled services.

According to the Energy Information Association, the U.S. natural gas industry is comprised of Producers (6,300), Processors (530), Pipelines (160), Storage (123), Marketing (260), and Local Distribution (1,200). These companies range from large integrated producers with worldwide operations and interests in all segments of the oil and gas industry, to small one or two person operations that may only have partial interest in a single well. Investors should note that these numbers change rapidly, as many companies enter and exit the market.

When investors are looking at stocks in the natural gas industry, the focus tends to be on dividends, as many utilities in this sector have moderate core growth, and expand mainly via acquisitions. As a result, the industry tends to attract income-oriented investors, who in turn, focus on a stock’s annual payout and its dividend yield. Dividend yields carry considerable weight with investors, as they are a strong sign of the company’s financial strength, and the balance sheet in particular.

That said, the recent depression in natural gas prices due to increased fracking activity causing excess reserves, appears to have resulted in many of these companies having sharper-than-warranted declines in their stock prices. As a result, long-term investors should find several stocks in the industry of note for their above-average projected appreciation potential. Indeed, improved long-term planning and fundamentals, coupled with an eventual bounce back in natural gas prices, should benefit Chesapeake Energy Corporation (CHK) and Talisman Energy (TLM) over the next several years. Readers can see below for partial results from our screen. Subscribers can adjust or recreate this screen using our online screening tool located here

Chesapeake Energy Corporation

Chesapeake Energy Corporation is an independent oil and natural gas production and exploration company. Founded in 1989, and based in Oklahoma City, Oklahoma, Chesapeake engages in the acquisition, exploration, development, and production of natural gas and oil in the United States. In addition to its primary business, the company also offers midstream, drilling, and other oilfield services. At present, it holds interest in several natural gas resources in Louisiana, Texas, Virginia, Pennsylvania, and Oklahoma. Chesapeake’s proved reserves comprise approximately 19 trillion cubic feet of natural gas, making it the second largest oil and natural gas production company in the United States.

Chesapeake is unique among natural gas outfits due to its business model, which often relies on nontraditional sources of funding. It buys rich liquid gas plays, and then recoups the money via joint ventures and volumetric production payments. The latter involves selling a percentage of production for cash payments. Both sources of financing have enabled the company to aggressively grow over the past decade.

Due to several management scandals, Chesapeake has recently been in the news. It currently faces an informal inquiry by the SEC due to the actions of its CEO Aubrey McClendon, who is accused of obtaining personal loans using his stake in the company’s wells as collateral. As a result of these allegations, he has given up his position as Chairman, as well as agreed to a major pay cut. Further board changes have taken place, with five directors leaving the board. Four new directors are set to be appointed, with one chosen by Carl Icahn.

The long-term presents some risk as asset sales may slow due to lukewarm demand for natural gas. Since asset sales remain a major part of funding, obstacles could crop up down the road. That said, the company has been in tight spots before, and has come up stronger and more profitable than in the past. We are cautiously optimistic that the board shakeup will yield more disciplined financial management. As a result of its recent woes, the company has seen a sharp decline in stock price, which, in our view, presents an attractive investment for many long-term investors who don’t mind some risk.

Talisman Energy

Talisman Energy is an oil and natural gas exploration and production entity, based in Alberta, Canada. Its main bases of operations are in North America, the North Sea, and Southeast Asia. The company engages in the exploration, development, production, transportation and marketing of crude oil, natural gas, and natural gas liquids.

Over the past three months, Talisman Energy has been leaving behind many of the obstacles that plagued it in 2011, and is likely to have a robust 2012. It has expanded into Australia, Jambi, Indonesia, and Columbia, which is likely to add to its volumes from 2013 onwards. The company is also shifting to a more oil rich portfolio, with wells in Kurdistan and Malaysia. In fact, its endeavors in Malaysia are set to provide Talisman with a major foothold to further expand into the Asian markets, especially India and China. As this endeavor has been ongoing for the past few years, and has recently left behind its many obstacles, we look for a rise in the top and bottom lines over the three- to five-year period.

Like many of its peers in the industry, Talisman’s stock price has suffered due to the natural gas price slump. Unlike many of its peers, however, Talisman is successfully transitioning to a more oil rich company, and has limited its investments in the natural gas fields. While we expect the company to receive a moderate boost once natural gas prices start to recover, much of our projected profitability is set to come from the various oil exploration and production plays the company has in store over the next few years. These projects are set to considerably boost the top and bottom lines, in turn making Talisman an attractive investment for long-term investors who are willing to bear some uncertainty (which comes from any company beginning a major new venture and restructuring).

Top 5 Stocks for three- to five-year price appreciation in the Diversified Natural Gas and Natural Gas Utility industries:

(1) Pengrowth Energy (PGH

(2) Quicksilver Res. (KWK

(3) Talisman Energy (TLM

(4) Chesapeake Energy (CHK

(5) Newfield Exploration (NFX)

At the time of this articles writing, the analyst has no stock in the aforementioned companies.