Cabot Oil & Gas Has Risen Like A Phoenix

Summary

• Cabot's shares have been under pressure for a while due to the unusually warm weather this winter.
• The winter has ended and as expected investors' attention has turned to the supply side.
• The recent plunge in crude oil prices was added to the negative effect on US gas output in 2020.

All of my last articles are dedicated to the US natural gas market and Cabot Oil & Gas (COG). I am amazed by how the value in this stock could be ignored for so long in times when investors are inclined to buy almost everything. Of course, commodities markets are not popular at the moment and the recession is coming at some point in the near future. However, looking closer at the natural gas market's balance in 2020, I became more certain in extreme undervaluation of Cabot Oil & Gas and attractiveness of this investment even with all the concerns of an inevitable recession.

This Friday, the faith in my valuation was finally rewarded with some evidence. Cabot's shares rose about 10% while S&P 500 index was trading more than 3% lower during the day.

Just look at this Friday's move higher, in spite of the fact that the natural gas price fell with the index and the crude oil.

Source: tradingview.com

Other gassy producers caught the bid too. The justification is about how lower oil prices will force oily producers in Permian to spend less, and with lower oil production from fewer wells will come less associated volumes of natural gas. It is a good justification. There is always a good justification after a significant price movement.

Maybe I am a bit biased but it is likely more in that rising of Cabot's shares than just a reaction on Russia quitting OPEC+. As I mentioned in my prior article, the current natural gas output in the Permian is about 11.2 Bcf/d. The takeaway capacity is roughly 10 Bcf/d. Kinder Morgan's (NYSE:KMI) next major gas pipeline, the Permian Highway, is expected to bring another 2 Bcf/d of Permian gas takeaway beginning in October 2020, which will push Permian gas takeaway to 11.9 Bcf/d. So, the most part of the upside from Permian this year is already in place.

Source: Enverus

The high case for natural gas production forecast on the chart above is based on the $70 per barrel WTI scenario. Given the current level for WTI, close to $40 per barrel, there might be the possibility for some decline even this year. However, it does not look like a strong positive factor given concerns about the weak LNG market and even economic slowdown, which would inevitably weight on demand. If I understand it right, the excess volumes in the Permian are going to the market this Autumn with the pipeline's opening instead of being burned down because of the lack of takeaway capacity.

Additionally, if such a strong bull case for the natural gas market appeared, why did not more operationally and financially leveraged producers rise at least as strongly as Cabot Oil & Gas? The closest follower was Southwestern Energy (SWN) with a rise of about +4%.

It looks like it had been brewing for some time. The company has got two good quarterly reports in a row after the strange one at the end of the Summer when management decided to give guidance for CapEx in 2020 without additional explanations about a worst-case scenario for the market.

Now we know that Cabot's maintenance capital program of $575 mn is expected to deliver an average net production rate of 2.4 Bcf/d. Daily production in 2019 was 2.37 Bcf/d. At a $2.25 average NYMEX price, the program is expected to deliver $275-300 mn of free cash flow. Even after Friday's movement, company's market capitalization is about $6.5 bn. Hence, at low natural gas prices scenario, FCF yield is expected to be roughly 5% in 2020.

It was mentioned in the presentation for investors that the company continues to analyze the outlook for the natural gas markets in 2020 and beyond and is prepared to reduce capital spending further if market conditions warrant it.

Additionally, the company is lowering its production cash costs. In 2019 cash operating expenses were $0.93 per Mcf comparing to $1 per Mcf in 2018. According to management's expectations, it could be improved further to $0.83-$0.89 per Mcf in 2020.

By the way, in the last presentation for investors, the forecast by BTU Analytics is illustrated with overall flat associated gas production expectations.

Source: Cabot's presentations for investors

One moment in the 4Q19 report looks negative. It is a quite high level for price differential of about $0.45 per Mcf. These concerns were eased by repeating the guidance for 2020 of $0.3-$0.35 per Mcf. It is a big difference for the company's financial results at this low level for natural gas prices.

The bottom line

The company looks in great shape financially. Even at low natural gas prices scenario, the FCF yield (roughly 5%) is quite attractive for commodity stock in the current environment. In my opinion, there might be positive surprises from natural gas prices going forward. The upside from associated natural gas is likely limited now after the Russian sabotage of OPEC+ deal. Even before the plunge in crude oil prices, the forecast for overall associated gas production was flat in 2020. There are risks from an economic slowdown and weak LNG market, but the company is well-positioned and can show some more days like what happened this Friday.

The undervaluation is extreme. My own fair valuation has not changed and stays at about $25 per share, taking into account the equilibrium price level for natural gas prices closer to $3 per Mcf.

Additional disclosure: This article is for informational purposes only. Please do your own due diligence before making any investment decisions.

Analyst’s Disclosure: I am/we are long COG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Frank the Frowner]

One good thing about COG is that they produced zero NGL revenue last year, it was all dry gas, so far as I can see. And of course, they have no exposure to oil shale, it's 100% Marcellus, which is good, oil shale production could be falling off a cliff.

One bad thing . . . practically no hedging. With gas demand way down and production slow to follow, prices should really pancake, meaning Q2 is going to look really, really bad.

Leaving CNX as the real winner here. It produces wet gas from the Marcellus, but it blends that with dry gas from the Utica to reduce processing costs, at the expense of liquids production, which is very small. That's good, NGL demand is going to be crushed, and of course prices are in the dumpster.

So, both COG and CNX essentially sell the same product from the same place, why is CNX different? Because it hedges, almost completely this year, 83% in 2021, with some material hedging in the next two years. Combined with the feedback from its own captive midstream, CNXM, CNX has costs just about as low as COG.

COG is good for the future, but they are going to have to ride out a real rough patch. CNX should be just about at guidance, regardless of gas prices, a bit down due to a small amount of liquids. But it's also possible they can increase the Utica content to tamp that liquid contribution down.

The one to own might be CNXM, they hinted at cutting back on the promised distribution growth, as would be expected, but CNX needs their payments over the next two years to help pay off their 2022 bonds. CNXM ran up on Friday huge, over $10 at one point, probably because it had been crushed while the parent was up the past six weeks, which makes little sense. Options expiration, short covering rally, whatever, it doesn't seem likely to stick when the market rolls over again next week . . . which is a lock, don't you think? CNXM likely won't even hold the $8's, so there should be more chances to buy yield super cheap that actually should stick during the apocalypse.

[Justanalysis]

Frank, your very intelligent with the midstream space, but I struggle to see the NG prices pancaking. In fact, quite the opposite. LNG just hit a record last week and has 20 year contracts. Res/commercial is only 24% of NG demand. A full nationwide shutdown analyst have said is only a few bcf/day, which will be more than offset in April if wells are shut-in to the extent companies are commenting. Last week Res/com took a very tiny hit, more folks at home offsetting commercial demand. Production has not fallen yet due to flared NG being injected into the pipes (reason given by other analysts). Once that's gone, I think you'll see a larger fall in production due to associated gas.

[Justanalysis]

Could be a good thing COG does not have hedges if NG does spike in April. CNX, although safer with hedges, won't enjoy the upside and hedges could become a headwind.

[Frank the Frowner]

Gas is at $1.60 going into spring, and if you want to see a preview of US gas demand, power use is down 20%, never mind industry. LNG prices have declined to the high $2's. Things are picking up a bit in China, prices around $3, and less floating ships. But it's hardly a good picture for US gas going into injection season.

[Tetragrammaton]

In principle, the selling price of natural gas, per BTU, should be about the same as the price of oil, per BTU. As the article accurately points out, the fracking industry is mostly dependent on the sale of its less volatile products (crude oil and “gas liquids”), but ends up simultaneously having to deal with annoyingly large quantities of methane, which it vents, flares or essentially gives away for free. The bull case of COG (which I have in my portfolio) is that COG economics will at some time in the future normalize on a BTU basis. At that hoped-for future time (maybe 2022), with crude in the 60s, we should see COG stock in the 30s per share, or about double its present price. Unfortunately, my geophysics background reminds me that geology, and thus future shale exploitation, provides the possibility for future throwaway methane production at many other sites around the world. In that case US NG prices, and particularly US LNG exports, would not provide happy hunting grounds for investors in natural gas names.

[theycallmejg15]

I bought some APR 17 calls. Hoping the downturn in oil spikes natty gas with the reduction of oil output that has to be coming soon