By selling off its Haynesville, East Texas, and Eagle Ford positions earlier this year, Cabot Oil & Gas Corporation (NYSE:COG) has more or less transformed itself into a pure-play on the Marcellus shale in Pennsylvania with upside in neighboring Ohio. What makes Cabot a very interesting company is that while a natural gas producer in a region with low gas prices, it has been able to consistently churn out sizable net income. Let's take a look at this Appalachian behemoth.
At the end of 2017, Cabot Oil held the lease on 172,000 net acres in Susquehanna County, Pennsylvania. That is core acreage within the Marcellus play capable of producing some of the most prolific wells around. Cabot expects to spend $940 million on capital expenditures this year, primarily for drilling and completion activities. This budget includes a modest amount for Cabot's expected contributions to its equity investments (part of its pipeline takeaway strategy). With three rigs and two completion crews operating across its acreage, Cabot has been able to continue delivering production growth this year out of Appalachia. Daily production growth is expected to grow in the high single digits this year versus last year's levels.
Cabot posted $282 million in net income during the first three quarters of 2018, including $122 million during Q3 2018. What made those results (especially in Q3) all the more impressive is that Cabot only produces natural gas. In Q3 2018, the firm pumped out just over 2 Bcf/d of natural gas equivalent net and realized $2.36 per thousand cubic feet of natural gas sold.
That was $0.54/Mcf below Henry Hub pricing, representing a sharp improvement from the year before when Cabot realized $0.99/Mcf below Henry Hub. For the first nine months of the year, Cabot Oil & Gas realized $2.32/Mcf. What that means is that in a $3 Henry Hub world, Cabot should be a very profitable enterprise. With a solid takeaway strategy in place, Cabot is increasingly able to access out-basin markets, improving its realizations and enabling production growth.
As natural gas prices skyrocketed in Q4 2018, expect Cabot Oil & Gas to post a banner quarter when it next reports its earnings. Management expects the company to produce 2.25 Bcfe/d net during the fourth quarter, a sharp increase from Q3 levels. Combined, that will allow Cabot to generate a lot of free cash flow according to its management. However, it is essential to keep in mind Henry Hub is expected to move back below $3 by April 2019 (versus ~$4 in Q4), according to the futures curve. Cabot Oil & Gas mentioned:
"Due to the recent improvement in the near-term outlook for NYMEX prices and basis differentials, we now expect to generate approximately $200 million of free cash flow during the fourth-quarter and approximately $250 million of free cash flow for the full-year, based on current strip prices."
During the first three quarters of this year, Cabot generated $789 million in net operating cash flow versus $82 million in dividends, $73 million in contributions to equity investments, and $648 million in capital expenditures. Asset sales generated $676 million during that period, enabling Cabot to retire $237 million in debt which will save the firm $15 million per year in interest expenses. The company repurchased $582 million of its stock this year through the end of September, and recently raised its dividend by 17%.
Going forward, Cabot is likely to retire its very high-yielding 9.78% senior notes this quarter. That burden had an outstanding balance of $67 million at the end of Q3 and easily could be serviced with Cabot's $316 million in cash on hand.
Management plans to scale down Cabot's 2019 capex budget to $825 million, but due to the prolific nature of the Marcellus shale and the Atlantic Sunrise pipeline project coming online in October 2018, the firm expects to grow its 2019 production by 22.5% on an annual basis. It is likely Cabot will be able to be free cash flow positive next year.
There isn't a lot of publicly available information on Cabot's ongoing activities in Ohio, but Marcellus Drilling News was able to uncover that Cabot plans to test formations deeper than the Utica in the state (for more detailed info on what formations are being targeted, check out that piece). Activity will be centered around Ashland, Richland, Knox, Wayne, and Holmes counties in north-central Ohio.
Cabot plans to drill several exploration wells in that area, as the firm understands one or two wells don't make or break a play. It takes numerous wells just to begin to get an understanding of what an upstream firm is dealing with. Any future updates on this activity should be quite interesting, but as always, there is a chance exploration activity comes up dry.
During the second quarter of 2018 Cabot announced that:
"Our adjusted net income for the quarter was impacted by $51.1 million exploration dry hole expense resulting from our decision to cease investment on one of our two exploratory operating areas."
It appears Cabot is still active in its other exploratory area, and management did bring up Ohio during Cabot's Q3 2018 conference call. It isn't clear where the first exploratory area is located, but considering the timing of Cabot management's talk with Ashland County's Times-Gazette (which was in April 2018, when Cabot was just getting started) and the Q2 2018 exploration charge (which was decided on by July 2018), it doesn't appear that the exploration expense could be related to the prospects MDN was highlighting (Cabot couldn't have drilled many wells in such a short period, if any at all, as it was still in the process of acquiring leases from landowners).
Cabot Oil & Gas Corporation is surprisingly profitable in a low natural gas pricing environment. With plans to lower its capital expenditures while still generating production growth, a product of additional takeaway capacity coming online, Cabot Oil & Gas Corporation is one of the few upstream players looking forward to 2019. As a gas producer, lower oil prices can in some ways behoove the company in the form of downward pressure on oilfield services rates. Thanks for reading.
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