Cabot Oil & Gas: Among The Attractive Exploration Stocks

| About: Cabot Oil (COG)

Summary

Cabot Oil & Gas has been among the relatively resilient stocks amidst the carnage in the oil & gas sector.

Cabot Oil & Gas has an attractive internal rate of return profile from both its core assets.

2015 capital expenditure program is fully funded. Low leverage and no near-term debt maturity provides financial respite.

The last FY15 guidance targets 20% to 30% production growth. Even if lowered from current levels, production growth will remain robust for FY15.

Overview

The sharp decline in oil price has resulted in a broad based carnage for oil & gas companies in the United States. Whiting Petroleum (NYSE:WLL) has declined by 54.9% from its 2014 peak of $92.66. Pioneer Natural Resources (NYSE:PXD) has declined by 38.5% from its 2014 peak of $233.07 and Chesapeake Energy (NYSE:CHK) has declined by 31.6% from its 2014 peak of $29.61.

These are few companies that I have mentioned in the current broad based carnage for the oil & gas industry. There are several other names that have corrected by 30% to 50% in the last 3 months.

In comparison to these companies, Cabot Oil & Gas (NYSE:COG) has performed relatively well with the stock declining by 20.6% from its 2014 peak of $41.61. Cabot Oil & Gas currently trades at $33.04. This article discusses the reasons why the stock is worth accumulating at current levels.

I want to specifically mention here that Cabot Oil & Gas declined by only 1.1% on Friday when other oil & gas stocks slumped. I therefore believe that markets see value at these levels.

In an uncertain environment, it is not possible to predict a bottom. However, gradual accumulation of Cabot Oil & Gas is a good idea considering the positives discussed below.

About Cabot Oil & Gas

Cabot Oil & Gas is an independent oil & gas company engaged in exploration and production of oil & natural gas. The company's asset focus is the Marcellus Shale where the company has 200,000 net acres and a current rig count of six. Further, Cabot Oil & Gas also has 86,000 net acres in Eagle Ford Shale with a current rig count of four.

As of December 2013, Cabot Oil & Gas had proved reserves of 5.5Tcfe. The company's reserves increased by a robust 41.9% as compared to December 2012 reserves of 3.8Tcfe.

The company's earlier focus was primarily on the Marcellus Shale. However, the company has sought diversification through increasing its acreage in the Eagle Ford Shale where the company has acquired an additional 33,000 acres in 2014.

Why Cabot Oil & Gas Is An Outperformer

Cabot Oil & Gas is an outperformer with the stock having declined relatively less as compared to other players in the industry. There are several reasons for the strength shown by Cabot Oil & Gas in difficult times.

One of the primary concerns for shale producers after the oil price slump is leverage and its potential impact on operations.

As this article from CNBC with the opinion of Neil Beveridge, senior oil analyst at Sanford C. Bernstein suggests -

While production growth is very strong [in North America], remember if you look at the debt situation for a lot of these companies, there is a lot of distressed debt... $68 a barrel is not economical for a lot of these shale oil wells. CDS [credit default swap] spreads and yields on some of the debt are rising very quickly, because at these kinds of oil prices you are going to see producers go bankrupt...

Therefore, leverage is a key concern and from this perspective, Cabot Oil & Gas is very well positioned.

As of September 2014, Cabot Oil & Gas had a conservative leverage position with debt to LTM EBITDAX of 1.2. While the company had a total debt of $1.6 billion as of September 2014, no near-term debt maturity is a big positive. Major debt maturity for the company comes only after 2017, and this ensures that there is no immediate term debt refinancing pressure.

Even from a liquidity perspective, Cabot Oil & Gas had a cash position of $310 million as of September 2014 and an undrawn revolving credit facility of $1.4 billion. With the company planning a capital expenditure of $1.53 to $1.6 billion for 2015, the current liquidity will be sufficient for the capital investment in 2015.

In addition to the existing liquidity and RCF, Cabot Oil & Gas generated an operating cash flow of $943 million for the nine months ended September 2014. While the annualized cash flow for FY14 will be in excess of $1 billion, even if the cash flows are moderate in 2015, the overall liquidity position will remain robust (supported by high operating cash flows).

Investors will question if I still expect strong cash flows in 2015 after the recent slump in oil & gas prices. The answer is on the positive and this is the second important factor why Cabot Oil & Gas has been relatively resilient.

On considering the economics for the Marcellus Shale, the reason for the strong resilience in the stock is clear. The company's all-source finding and development cost for 2013 in the Marcellus was $0.55 per Mcfe and the current Marcellus Shale economics ensures an IRR of 102% even at $3 per Mcfe natural gas price.

Cabot Oil & Gas expects realized natural gas prices (on a conservative basis) to be $2.8 per Mcfe and this implies an IRR of greater than 80%.

Therefore, even with the decline in oil & gas prices, Cabot Oil & Gas remains well positioned to generate a strong IRR from its major asset. I therefore expect the company's operating cash flow to remain robust in 2015 even if it's relatively lower than 2014.

In terms of the above mentioned capital expenditure allocation, 52% will be towards the Marcellus Shale and 46% towards the Eagle Ford Shale. Therefore, with a significant investment in the Eagle Ford Shale, it is also important to look at the IRR for the Eagle Ford asset.

According to the company, the Eagle Ford asset will generate an IRR of 34% even at $70 per barrel oil.

While oil is currently trading at below $70 per barrel, the returns profile remains attractive even on margin recovery in oil price.

I must add here that the negative factors for oil prices have largely played out and oil will see another sharp decline only if there is a global recession in 2015.

I assign low probability to that outcome and I believe that the fear related to $40 per barrel or $50 per barrel oil is overdone.

On the demand side, China has already boosted its oil imports to 460,000 barrels per day in the first nine months of 2014 according to this Bloomberg report. In 2015, the country expects to boost its imports to 700,000 barrels a day. Oil demand is also likely to pick up in India where growth is accelerating after the formation of the new government, which is focused on growth and development.

The point I am trying to make is that the decline in oil prices is being used as an opportunity by big oil consumers to hoard oil and therefore the demand is likely to remain relatively strong in 2015.

With oil prices having discounted the major negative factors, there can be potential upside coming in 2015. Even if oil prices hover around $70 levels, Cabot Oil & Gas will be in a position to generate modest IRR from the Eagle Ford Shale.

According to the company's outlook for 2015, the likely production growth is in the range of 20% to 30%. The company had provided this guidance on October 24, 2014. However, with oil prices declining sharply in the recent past, the production growth guidance is likely to be trimmed. Even if production growth is in the range of 10% to 20% for the coming year, the overall cash flow would still remain attractive considering the IRR for the assets.

Considering all these factors, I believe that Cabot Oil & Gas is worth considering at current levels and investors can gradually accumulate the stock. Another 5% to 10% correction in the stock (on any further oil price decline) can make valuations even more mouth watering.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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