Cabot Oil & Gas (COG) turned in a stronger than expected third quarter, essentially meeting analyst expectations on revenues while handily beating expectations on earnings per share, posting $0.21 earnings per share where analyst estimates compiled by S&P Capital IQ expected to see $0.14 per share. This earnings coup is attributable to increased production and lowered margins, and is a sign of Cabot's underlying strengths.
The Marcellus: Full Speed Ahead
Cabot is attributing its drilling in the Susquehanna County area of the Marcellus in particular with much of its natural gas production growth. Cabot is seeing outperforming wells on the Marcellus completed with only 25 frac stages, using narrower spacing of approximately 200 feet according to Cabot Chairman, CEO and President Dan O. Dinges. But Cabot can, and in fact is, going lower; a 22 stage well recently reached 3 bcf of cumulative production in 105 days.
Like other natural gas dependent E&Ps, Cabot intends to increase its Marcellus drilling. During the company's third quarter conference call Dinges indicated that it will add a rig to this play during 2013, with a further rig coming in 2014. For now Cabot is one of the only drillers talking about increasing Marcellus activity, although competitor Anadarko Petroleum (APC) is not discounting the possibility of bringing greater resources to the Marcellus so that it can join Cabot in the enjoyment of a natural gas price recovery.
With natural gas prices are holding steady, drillers like Cabot are poised to deliver growth while better gas/liquids mixed producers like Anadarko are content to focus on higher margin properties. Investors are cheered by Cabot's 61% year over year growth in liquids, but in perspective, liquids still account for just 6% of Cabot's overall production. Still, Cabot anticipates being able to close out this year with overall liquids growth between 60 and 70%, and hopes to post similar numbers next year, giving guidance for 2013 liquids production growth between 45 and 55%.
Growth in Liquids a Support, not a Driver
Much of Cabot's liquids growth is coming from its activities on the Eagle Ford, and will soon be supplemented by production on the Pearsall shale. Cabot is new to the Pearsall, with just one well completed and thre wells drilling to date. It is drilling here through the auspices of a joint venture with Osaka, and hopes to complete up to six wells on the play by the end of this year. Its inexperience with Pearsall drilling is leading to slightly inflated drilling costs; its first well reportedly cost just over $10 million to complete, although Cabot hopes to bring that number down as it gains its traction on the play. Although Osaka is carrying 90% of the drilling costs, Cabot will exhaust the drilling carry much more quickly with these high costs, and certainly needs to focus on bringing those costs down.
Cabot is doing very well on the Eagle Ford, where it is concentrating in the Buckhorn area. Its cost per well on this play is now between $6.5 million to $7 million, again in part due to reduced frac stages. The cost reduction is also being driven by the resources being thrown at the play; now that the Eagle Ford is essentially leased out, players are investing heavily in completion and production. Cabot competitors EOG (EOG), ConocoPhillips (COP), and Pioneer Natural Resources (PXD) are the top three as far as desirable acreage in the Eagle Ford's condensate and oil windows, where Marathon (MRO) also holds significant if not as competitive acreage.
The cost to amass such acreage explains why Cabot did not take on a greater presence in this area; across 2011, though the average price per acre hovered around $14,000, lease prices for the most desirable Eagle Ford acreage reached $25,000 an acre. However, because of the Eagle Ford's rich resource base and quick scaling to full production, Cabot is able to make a noticeable improvement in its liquids numbers even with a smaller position. Its smaller position is also allowing it to leverage the reduced costs associated with the resources liquids bulls are putting into the Eagle Ford. Although the relatively small liquids production Cabot is reporting from the play isn't providing it with any huge advantages, I think this at least gives Cabot a desirable hedge to help it through mid-2013, when a real rebound in natural gas prices is likely.
Cabot is currently trading around $48 per share, surging ahead 10% since its strong earnings report. This gives it a price to book of 4.9 and a forward price to earnings of 55.8. For comparison, Anadarko is trading around $70 per share, with a price to book of 1.8 and a forward price to earnings of 18.1. EOG is trading around $117 per share, with a price to book of 2.4 and a forward price to earnings of 18.2. Marathon is trading around $30 per share, with a price to book of 1.2 and a forward price to earnings of 9.0. Pioneer is trading around $109 per share, with a price to book of 2.5 and a forward price to earnings of 20.6.
At first glance Cabot might appear overvalued compared to these other independent peers, but its natural gas portfolio is currently discounted. Its natural gas properties are currently undervalued to their potential, and its forward price to earnings is inflated by the current price environment. As the natural gas recovery staggers ahead, Cabot has huge potential for massive gains, and not necessarily that far into the future. According to Dinges, Cabot is poised to "deliver industry leading production growth in 2013, with a cash flow positive program using a $3.50 gas price." I think what we're seeing now with this stock is just the beginning.