In today’s Daily Alert, The Energy Strategist Editors recommend an aggressive play on natural gas prices and the Marcellus Shale.
“Oil is expensive, gasoline prices are pushing $4 a gallon but natural gas is cheaper than it was in 2000. And yet one the strongest-trending S&P 500 stocks belongs to a gas producer that has outperformed all the crude drillers and even most of the red-hot refineries.
“Cabot Oil & Gas (COG $68 NYSE) is a leading natural gas driller in the Marcellus Shale, the energy-rich shale rock formation covering 60% of Pennsylvania and stretching into New York, Ohio, West Virginia and Maryland. The Houston-based independent is coming off a record-setting year in which it boosted its production 43%, and grew cash flow from operations by 30%.
“Much of this came courtesy of the Marcellus, which is now yielding a quarter of the U.S. output of natural gas after production nearly doubled last year. Cabot’s slice of this new Eldorado amounts to a net of 200,000 leased acres concentrated largely in the Susquehanna County of northeast Pennsylvania between Scranton, PA and Binghamton, NY.
“The Marcellus yielded 209 billion of cubic feet equivalent (Bcfe) of natural gas to Cabot’s 224+ wells last year, representing 78% of the company’s output. That’s a good thing, because the Susquehanna County and Cabot’s huge Dimock gas field there are, as CEO Dan Dinges puts it, ‘in the sweet spot of the most prolific natural gas field in North America.’ The company had 15 of the top 20 producing wells in Pennsylvania’s Marcellus last year. Cabot’s ‘rates of return in Susquehanna County rival or exceed all of the top U.S. liquids plays at current commodity prices,’ the company said late last year in an investor presentation.
“This year is looking even better than the last, with production forecast to increase another 35% to 50% while capital spending plateaus. That should allow Cabot to fund its development program largely from cash flow, which should comfortably outstrip spending needs down the road.
“On the most recent earning call, when analysts weren’t drilling down into Cabot’s exceptionally strong drilling results and the (solid) prospects of duplicating them across the company’s undeveloped Marcellus acreage, they were wondering what Cabot might do with the excess cash flow it’s due to start piling up next year. Given the company’s five-year development plan, ‘and looking at the amount of free cash we have and debt paydown that we can do, Scott [Schroeder, the CFO] just walks around the office with a big smile,’ CEO Dinges responded.
“Schroeder proceeded to tell the analysts that Cabot will use the cash to fund the construction of the Constitution Pipeline that will link its fields with the major Northeast and Canadian consumer markets in 2015, accelerate the Marcellus development fueling its returns and lastly consider ‘dividends of one form or another.’
“Right now, Cabot seems awfully expensive on a nominal basis, trading at 50 times estimated 2013 earnings and 27 times analysts’ 2014 projection. But earnings per share are not the best valuation metric for energy companies writing off huge non-cash depreciation costs.
“More informative is the EV/Ebitda ratio, which adds debt to the market capitalization to arrive at the enterprise value, then divides that sum by earnings before interest, taxes, depreciation and amortization, a proxy for cash flow. On that basis, Cabot is priced at roughly 21 times trailing Ebitda, not cheap but plenty reasonable for a company that’s increased production by more than 40% in each of the last two years and figures to make it three in a row in 2013. And there’s lot of runway straight ahead: proved reserves rose 27% in 2012, to a number large enough to support 14 years of production at last year’s record pace. The company added more than four times the reserves it extracted last year. ...
“The stock has doubled over the last nine months and is up 31% to a record year-to-date, so we wouldn’t have qualms with anyone waiting for a 5 to 10% correction before buying. But it’s likely to provide lots of future value even at current levels. COG is a new Growth Portfolio buy; add it below $72.”
- Robert Rapier and Igor Greenwald, The Energy Strategist, March 13, 2013