In the last week, analysts at Tudor Pickering downgraded both Cabot Oil & Gas (COG) and Petroleo Brasileiro SA, more commonly known as Petrobas (PBR) from "buy" to "accumulate". Capitol One also lowered its rating on Cabot, from "add" to "neutral". May was a hard month for exploration and production companies, and I think that a wave of negative publicity from Chesapeake Energy's (CHK) various scandals was at least in part to blame.
Energy stocks frequently dip after first quarter earnings season even without a Chesapeake in the mix, and the alert can benefit by picking out the energy stocks that are depressed by these reactions. Cabot's stock peaked at or just below $36 several times in the last 30 days and is currently 30% below its 52-week high. Cabot is on a trend, indicating it may soon reach its one-year resistance around $30, so those who are waiting for the stock to trade lower may have a buy-side opportunity in the near future.
Recent Success on Multiple Plays
Shortly after resuming operations on the Marcellus Shale, following fire damage to the Lathrop Compressor Station, Cabot announced that it was averaging 78 mmcf of natural gas from five wells near the eastern edge of its Marcellus acreage. Dan O. Dinges, Cabot's President and CEO, stated:
if there was concern about the productivity of our eastern acreage, those concerns should be mitigated.
Cabot is making use of the zipper frack technique to maximize its relatively small acreage holdings, beginning with the Eagle Ford Shale. Its down-spacing pilot program was drilled with the horizontal legs spaced at 400 feet, and Dinges noted:
the wells have 24-hour production rates of 788 and 791 barrels of oil per day, which is greater than the average initial rates for our entire producing portfolio of Eagle Ford wells.
I think that this oil success indicates that, though it may be more difficult, it is not altogether impossible for Cabot to reduce its reliance on natural gas after its strategic delay in making the transition.
Legal Proceedings Shadow Mid-Growths
Cabot is also participating in an Utica/Point Pleasant wet-gas test well with competitor Range Resources (RRC). Cabot may want to step carefully here, as Range is currently facing a lawsuit from residents on the Marcellus Shale, which alleges that Range and its water-testing companies provided fraudulent testing results. The families also allege that they have suffered various health issues related to water contamination brought on by a leak in a water disposal well's pit liner. Range recently saw a similar case brought against it in the state of Texas dropped, since the state regulator overseeing the incident determined Range was not responsible prior to the case.
The Environmental Protection Agency is re-sampling private water wells in the same area near Cabot's operations for testing, though the EPA, Cabot, and the local Department of Environmental Protection, previously determined that the contamination levels in the wells did not require action. In 2010, Cabot settled a lawsuit over well water contamination for $4.1 million in the same area. Paired with the above mentioned suit pending against Range, it appears that residents in this area are particularly litigious, which could impact these companies' ability to continue operating in a gas-rich but highly populated area. These types of cases should also be informing Occidental Petroleum's (OXY) recent decision to lay the groundwork for drilling and possibly fracking within the boundaries of the populated city of Carson, California.
Though many governments and private institutions declare that fracking is safe overall, as more independent oil companies like Cabot and Range enter the exploration and production field, the scrutiny over the practice is bound to increase. Although nearly all energy producers from supermajors down to Kodiak Oil & Gas (KOG) are using or testing fracking, Cabot, Range and Chesapeake rely on fracking almost exclusively as an extraction tool. Increased scrutiny falls disproportionately on these small to mid-growth companies, given that residents are most familiar with these names.
For this reason, I am somewhat concerned about the pending lawsuit against Range and the potential for another lawsuit against Cabot, especially given the infractions of which these companies are accused happened close to the time that the shale plays were inaugurated. The technology in use then was far behind the technology producers are using now, but it is unlikely that residents or legislators will see it that way without protracted presentations and, potentially, legal cases. The fact that the number of fracking incidents in Pennsylvania declined by 50% since 2008 is a mark in these energy companies' favor.
Cabot reported earnings per share of $0.09 in the first quarter, up from the first quarter of 2011 when it reported earnings of $0.06 per share, but far below the fourth quarter of 2011, when it reported earnings of $0.20 per share. On a year to year basis, Cabot's earnings per share are not consistent, indicating a variability in its revenues that is less than desirable. Cabot reported EPS of $0.59 in 2011, $0.50 in 2010, $0.72 in 2009, and $1.05 in 2008, spreads that are not perfectly correlated to external factors, such as dry gas prices or gains on sales.
One explanation for Cabot's results is that, unlike many of its peers, Cabot is actually increasing natural gas production, in which it reported an increase of 55% in the first quarter of 2012 compared to a year prior, though it also increased oil and liquid natural gas production by 138% over the same period. Cabot still relies on natural gas for over 75% of its revenues, worrisome as few are predicting a return to normal natural gas prices in the U.S. any time before 2014. While SandRidge Energy (SD), Kodiak and others changed strategies to accumulate liquid reserves, Cabot largely continued drilling for natural gas, and this strategic error is showing in its earnings and its ratings downgrades.
Even so, Cabot maintains that its natural gas production on the Marcellus remains economically viable, and it plans to continue forward on a plan of 'controlled growth' with a slightly expanded focus on liquids. In this respect, Cabot is finding itself in a similar position as competitor Chesapeake. I believe Chesapeake also waited too long to make a significant effort towards liquid reserve acquisition and production, and so these companies are caught in a position where lowered revenues from current gas prices prevent any truly substantial progress. Cabot, however, is not enmeshed in anything like the debt mess that Chesapeake acquired, and neither is Cabot facing accusations of corporate malfeasance or misgovernment.
Currently trading around $32, Cabot has a forward price to earnings of 36.8 and a price to book of 3.2, which excludes it from consideration as a value buy. However, I think that the company overall is strong, and investors' long-term predictions on natural gas price trends should drive any investment decisions on this stock.