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We are maintaining our Neutral recommendation on Southwestern Energy Company (NYSE:SWN) with a target price of $40.

An independent energy company, Southwestern Energy is involved in theexploration, development and production of natural gas and crude oil in the United States. The company has two operating segments: Exploration and Production, and Midstream Services.

In the recently reported fourth quarter and full-year 2010 results, Southwestern Energy matched our expectations with quarterly earnings of 43 cents per share and full-year earnings of $1.73 per share. The company registered oil and gas production of 111.4 billion cubic feet equivalent (Bcfe) (up 25% year over year) in the quarter, reflecting strong contribution from the Fayetteville Shale operations.

Management expects the total oil and gas production to range between 465 Bcfe and 475 Bcfe for 2011, up about 15% to 17% from the full-year 2010 level of 404.7 Bcfe. We believe that the company’s large core properties along with its low-cost operational facilities exhibit a strong long-term upside potential.

Apart from the Fayetteville Shale, the Appalachian basin holds growth prospects, with production expected to accelerate in the coming quarters. Southwestern aims to invest approximately $265 million in 2011 (versus $118 million in 2010) and drill 40 to 45 wells (versus 21 wells last year).

Additionally, Southwestern has a strong balance sheet with significant liquidity and financial flexibility as well as a large drilling inventory. With continued focus on return on investment, the company is set to create significant value for shareholders.

However, Southwestern Energy remains vulnerable to unstable movements in crude oil and commodity prices. With natural gas making up most of the company’s reserves and production, the results are exposed to the negative near-term outlook for natural gas. In our opinion, an oversupplied US natural gas market coupled with lower demand, provides little space for Southwestern to flourish.

Another factor that adds to our negative sentiment is Southwestern’s lack of a geographically diversified asset portfolio. The majority of the company’s activities are concentrated in Fayetteville Shale, Arkoma and East Texas fields, which faces technological disruptions risk, harsh weather conditions and high services costs. These headwinds will likely weigh down on the company’s profitability in the near-to-medium term.

Southwestern, which competes with peers such as Chesapeake Energy Corporation (NYSE:CHK) and Williams Companies Inc. (NYSE:WMB), currently has a Zacks #3 Rank (short-term Hold recommendation).

Source: Southwestern Energy Remains Neutral