Cabot Oil & Gas Corporation (COG) emerged from the second quarter bruised, due to higher production costs and depressed natural gas prices that impacted cash flow and revenues. Excluding one-time items, Cabot still managed to report earnings at $0.17 per share, down 45% from the second quarter 2011 when it reported earnings of $0.26 per share. With one-time items, Cabot's earnings were $0.05 per share.
One reason Cabot was able to report positive earnings is its higher production numbers; the company increased production in the second quarter by 40% over the quarter a year ago, with an impressive 96% growth rate in liquids and a 37% growth rate in natural gas. In the company's earnings call, Chairman, CEO, and President Dan O. Dinges was careful to point out that these production gains came despite unscheduled maintenance and downtime on its gathering lines that significantly reduced the company's Marcellus production, with an estimated 5 bcf of production lost due to these activities.
Increasing Production to Make Up the Difference; Targeting Marmaton
Cabot is taking production increases seriously, and is working on alternative frac methods to increase its flow rates on the Eagle Ford and Marcellus, including zipper fracs and downspacing. Cabot is counting on the Marcellus for the majority of its growth, and will maintain four rigs operating on the play through the end of 2012. In the second quarter, Cabot brought five wells to production with IPs exceeding 20 mmcf per day, as well as a two-well pad that averaged nearly 60 mmcf per day in its first 39 days. The company is reducing frac stages in test programs to determine optimal downspacing and frac spacing in line with reduced costs, and is seeing results that exceed expectations on 15 stage fracs, even as it explores new areas to the east of its main operations.
Thanks to its joint venture with Osaka Gas Co. Ltd., Cabot can aggressively pursue its encouraging results targeting the Marmaton in the Granite Wash, with two rigs operating and funded by cash and carry generated through the joint venture. Its average IP for the most recent five wells drilled came in over 1,100 barrels of oil plus natural gas and liquid natural gas, at a drilling cost between $2.9 and $3.4 million. Competitor SM Energy (SM) saw less impressive results overall and will have two rigs operating by the end of September, down from three rigs currently, based on low natural gas liquids pricing that is dropping SM's returns below its ideal targets. However, SM is likely to keep its activities in the Marmaton warm, considering one of its most recent wells, McEntire 2-27H, provided seven-day average production of 14.0 mmcf per day and 30-day average production of 12.9 mmcf per day, a respectable fall off.
Devon Energy (DVN) is also enjoying success on the Granite Wash, averaging 30-day IP rates approaching 1,300 boe per day. Devon has plans to expand its Granite Wash presence, and aims to add a fourth rig to the play by year end. Forest Oil (FST) is even more aggressive, placing as one of the largest acreage holders on the Granite Wash, with 109,000 net acres in the Panhandle. This also includes areas where the company is targeting the Hogshooter formation, an area where Cabot is not yet focusing, but one where Forest and competitor Chesapeake Energy (CHK) are seeing success.
Given that one of Forest's Hogshooter wells had a 24-hour production rate of 1,500 barrels of oil, 570 barrels of natural gas liquids, and 4.4 mmcf of natural gas per day, and that Chesapeake drilled a well that averaged daily production of 5,400 barrels of oil, 1,200 barrels of natural gas liquids, and 4.6 mmcf of natural gas per day, Cabot may well take the initiative to drill the Hogshooter after it gains its footing in the Marmaton.
Cabot is currently trading around $42 per share, with a price to book of 4.2 and a forward price to earnings of 42.3. Although it turned in a firm second quarter despite challenges, I think that these numbers put Cabot at a premium that is not worth the cost, especially when compared to its peers. SM is currently trading around $47 with a price to book of 2.0 and a forward price to earnings of 16.1, still pricey but a better deal than Cabot as the companies are facing many of the same challenges. Devon is trading around $60 with a price to book of 1.1 and a forward price to earnings of 8.5, a clear value buy by comparison.
Forest and Chesapeake are facing issues in addition to depressed natural gas prices, rising costs, and increased regulation. Both have debt to equity ratios that are worrisome and a lack of strong leadership at the top, making them less directly comparable to Cabot. For reference, Forest is trading around $8 per share with a price to book of 1.3 and a forward price to earnings of 6.0, and Chesapeake is trading around $20 with a price to book of 1.0 and a forward price to earnings of 9.6.
Cabot is not getting discouraged as low natural gas prices continue to drag on the company's profitability; Dinges provided a peek at the company's early 2013 guidance, which calls for production to "grow by a minimum of 30% to 50%, with a capital program between $900 million and $1 billion." With that capital outlay, I believe Cabot will be able to reach a 30% production growth target, although 50% seems unlikely if natural gas prices remain low; if anything, I think Cabot would see the folly of developing natural gas plays below the cost of production and adjust its targets during the year if it went ahead with the 50% guidance.
Either way, Cabot has room for growth in the next few years, and though it is less successful than some of its peers at navigating today's challenges, it is not sliding downwards like Forest and Chesapeake. At present, I think Cabot is a firm hold, and a buy once it drops below $38.