Societe Generale began analyst coverage of Cabot Oil & Gas (COG) on April 24, and inaugurated coverage by awarding Cabot with a buy rating. Societe Generale's rating matches the buy ratings previously announced by Canaccord Genuity and Ladenburg Thalmann. However, the mean analyst recommendation is at hold, which I agree with given Cabot's slight overpricing, as discussed below.
Cabot will release first quarter 2012 results on April 26. Cabot's results are unlikely to be materially impacted by its one-week production halt on the Marcellus shale, which was caused by a flash fire at the Lathrop Compressor Station. According to Cabot, it was moving 365 mmcf per day through Lathrop at the time of the incident. As of the end of 2011, Cabot operated fifteen of the top twenty dry gas wells on Marcellus. However, the shut down only impacted the last two days of the quarter.
Cabot is indicating that it is relying heavily on Marcellus as a future profit driver, as it plans to allocate up to 65% of its annual investment dollars to projects on this play "for the foreseeable future." Cabot is also hedging falling dry gas prices with a renewed focus on liquids in the Eagle Ford shale and Marmaton. According to Cabot, these two plays doubled its liquids proved reserves in 2011, and it plans to add to its prospect inventory for oil.
Like competitor Chesapeake Energy (CHK), Cabot is converting its fleet to run on compressed natural gas (CNG), though Cabot is not jumping as wholeheartedly into the venture. Cabot currently plans to upgrade only half of its local light-duty fleet to the alternative fuel, noting that the lack of fueling stations in many parts of the country hinders the roll-out. Cabot just might take advantage of Chesapeake s plans here, allowing Chesapeake to do the heavy lifting of converting gas stations to the CNG playbook.
On April 25th, Cabot announced an agreement to transport 500 mmfcd through the Constitution Pipeline Company LLC, a joint venture it shares with Williams Partners LP (not traded). Cabot owns a 25% interest in the pipeline, which will connect Williams Partners' gathering system in Pennsylvania to Iroquois Gas Transmission and Tennessee Gas Pipeline systems in New York.
Increased concerns in the US over earthquakes caused by fracking and disposal wells could inhibit Cabot's operations, as well as the operations of its competitors. Recently in the UK, Cuadrilla Resources Limited (not traded) stopped production in that country before resuming under precautions recommended by the UK Department of Energy and Climate Change.
In its presentation at the Howard Weil Energy Conference in New Orleans, held at the end of March 2012, Cabot indicated it was focusing on plays in Marcellus, Eagle Ford, and Marmaton/Penn Lime.
Cabot's most recent presentation ahead of first quarter earnings indicated that its sale price on gas has dropped precipitously, from $8.39/mcf in 2008 to $4.46/mcf in 2011. However, Cabot previously indicated that its production costs are below $3.00/mcf, so this margin, while slim, is adequate to maintaining a profit.
An unusually mild winter for the US and low dry gas prices are resulting in more bcf remaining in storage. The storage capacity is stressed enough that inventory levels are predicted to reach 220 bcf above US storage design capacity by November, should gas demand remain low. This would not only have the effect of driving prices even lower, but could also force well shutdowns for Cabot and others if there is nowhere to store excess production.
Cabot experienced record production growth in 2011, increasing production by 43.5%. It also increased proved reserves to 3.0 tcfe, impressive as it only reached the 2.0 tcfe milestone in 2009. Cabot ended 2011 with a gross success rate of 99%, which seems incredible until one remembers that Cabot operates only in the US and focuses almost entirely on plays already explored by competitors. As a strategy, this is allowing Cabot to leverage its relatively small weight against the larger players. This strategy allowed Cabot to achieve reserve replacement of 390% in 2011 while increasing total production by 56.9 bcfe year over year. By continuing with this strategy, Cabot could continue to grow revenues despite falling market prices on its commodities.
As Chesapeake, Devon Energy (DVN), and Range Resources (RRC) also focus operations on the North American continent, Cabot is facing increasing competition for acreage on popular plays like Marcellus and Eagle Ford. However, Chesapeake, lacking in storage space and possibly doubting a return to profitability on dry gas alone, is retreating from dry gas wells to focus on liquids. Cabot has not announced plans to retreat from dry gas, and its most recent guidance indicates that Cabot plans to explore liquids further as it continues to extract from its existing gas wells.
Given Chesapeake's troubles with its leadership and balance sheet, Chesapeake does not pose much threat to Cabot in the near future. However, Range Resources presents strong competition for Cabot. Range Resources was one of the first energy companies to explore Marcellus, and is directing 86% of its capital budget to develop its resources here.
Though its presence on Marcellus is strong, Range Resources has a narrow margin of 4.8%, and is currently trading around $60 with a forward price to earnings of 36.7 and a price to book of 4.1, despite negative revenue growth over the past three years. Devon has a more satisfying margin of 41.1%, though it also submitted negative revenue growth over the past three years. Devon is currently trading around $68 per share, with a forward price to earnings of 9.3 and a price to book of 1.3, compared to Cabot trading around $31 per share with a forward price to earnings of 26.6 and a price to book of 3.1.
Given that Chesapeake is currently trading around $18 per share with a forward price to earnings of 6.4 and a price to book of .9, and Marcellus-focused competitor Southwestern Energy (SWN) is trading around $30 with a price to earnings of 17.8 and price to book of 2.6, Cabot and Range Resources look expensive. Although Cabot has a better than average debt to equity ratio of .6, compared to Range Resources at .8, Cabot is not attractive at its current P/E, though I would rate it a hold for those already owning the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.