Southwestern Energy: Bright Future Ahead

Summary

• SWN is set to see strong positive cash flow for years to come given the current energy environment.
• SWN is highly leveraged, but they are focused on cutting that in half over the next year which makes things much more attractive.
• SWN is facing major resistance. A break above $4.85 is very bullish.

Photo by straga/iStock via Getty Images

While the energy dip goes on, I continue to look for companies to add for the next leg up over the next few months. Southwestern Energy (NYSE:SWN) is one that has been on my radar over the last year. The company is heavily leveraged, but plans on cutting it in half over the next year which makes the company much more attractive. They do not have much debt due in the short term, and a positive energy environment is going to boost free cash flows to levels we have not seen in years.

What's Going To Drive Them Forward?

3 words, free cash flow. The company is set up to capitalize on the current environment which will boost free cash flow after a few years of instability. For 2020 the company posted ~ negative $242 million in free cash flow. If not for a fourth-quarter that saw $55 million to the good show, that number could have been a lot worse. What does this mean for 2021/2022? Well as you can see below in the quarterly breakdown, the bars are all on the right side of the line. Analysts are expecting to see ~ $326 million and $348 million in free cash flow over the next two years. This will go a long way to paying down debt and cleaning up the balance sheet. More on that later.

Our plan optimizes free cash flow, guidance is based on a $2.77 per Mcf NYMEX gas price resulting in projected free cash flow of over $275 million. An increase to a $3 gas price would result in free cash flow estimates in excess of $375 million and these scenarios result in a reinvestment rate between 70% and 80%

- Bill Way, President & CEO

Part of this is going to come from increased demand in the overall energy market. There is no debate that we will continue to need energy, the debate is around the source. The company believes that if we are going to be a low carbon world, natural gas is going to be a staple. Experts would tend to agree. We are expecting to see about a 20% demand increase in energy over the next 20 years, which includes a ~30% increase in natural gas demand. It's not as hot as renewables, but as you can see below it will still be a dominant force in the industry without a doubt.

A big piece of the puzzle is that the company is going to focus on building value over growth. This may worry some, but given the balance sheet and leverage (which I will address later), it is much needed at this point. There is nothing wrong with that when you already have good assets and you're set up to grow free cash flow as is. Growing value will in turn lead to better growth down the road. If you want to see a prime example of this, all you have to do is take a look at what they are doing with regards to cutting costs. Examples can be seen below. Well costs are expected to average $600 per lateral foot. This is a 10% reduction from 2020, which is becoming the standard as of late. Their average lateral length should increase to 14,000 feet as well.

(Source: Company Presentation)

This isn't a new initiative by any means. In 2020 they also lowered costs, reduced cycle times, drove efficiencies, displayed agility, increased productivity, progressed our resource to reserves effort and enhanced returns.

How Is Their Hedge Book?

Keeping good hedges is a great way to earn extra profit and help protect yourself from crashes as we saw in 2020. Many who had strong hedges fared very well. The company posted a total net gain of ~$362 million from their hedging program that contains but is not limited to Natural Gas, Crude, Ethane, and Propane. The natural gas hedges returned just under 70% of the total at $249 million.

(Source: Company Presentation)

As you can see above, the company is already hedged across the board well into 2021 and even into 2022 which is fairly aggressive. This could bite them in the butt a little bit depending on what happens in the energy environment. The company has said that they have hedged the majority of their 2021 production across all product mixes, but strategically retained upside participation through the use of collars. The big concern that they are protecting against is the risk of widening basis in the Appalachia Basin. I think it is a smart move just in case something happens that is out of their control. There is something to be said for predictable revenues.

How's The Balance Sheet?

It is always wise to look at the balance sheets of oil & gas companies especially with what has transpired over the last year. Usually, the big question is around the debt situation. The company has been very open about a 2x Net Debt/EBITDA within a year from now. From what I can tell the company is currently sitting at 4.81x as of 12/31/20, which is less than ideal. For reference, the company was at 2.11x a year ago. 2020 was a challenging year for the entire sector, but 4.81x is not where the company wants to be right now.

(Source: Company Presentation)

The good news here is that there isn't much debt due in the next few years. There is $207 million due in 2022, but nothing after that until 2025 which gives the company plenty of time to commit to paying down debt. The company does not pay a dividend and they aren't about to start one which helps the path to debt reduction easier. Should we see the energy environment improve over the next year, this goal will happen a lot quicker as the company has said that any benefit to the current pricing will be attributed to strengthening the balance sheet. They are saying all the right things. The question comes down to how much of an impact will it actually have.

What Does The Price Say?

Diving into valuation, we can look at what the "fair price" for the stock is. Examining 10-year forward levered cash flows, we get roughly $10.45. This would mean the stock has to more than double to get to "fair" value. Now, how accurate is that? While that is an aggressive target, I do think the stock will get there with the increased demand for natural gas over the next 5-10 years. In the shorter term, I think the stock could make a run for $6 which would give investors about a 25% return from today's price. I do not think this is a stock that will see the explosive growth that others could see in the industry, especially seeing as the stock is already up over 300% from the lows a year ago.

(Source: Simplywall.st)

As for some of the technicals, the first thing that grabs my attention here is the 50-day moving average. I want to start out by saying that it is no perfect, but there is clearly some support here. Especially as of late. The stock has bounced off of it very nicely over the last year as the stock recovers from the COVID crash. Had you been buying over the last few months on every touch, you'd be sitting pretty at this point. I trust the support until it no longer becomes support. As you can see below the stock has spent more time on the right side of this moving average as of late and as long as that holds true, you can be confident in your position.

(Source: TC2000.com)

While I haven't written on Southwestern before, it was on my radar. And where we stand today was flagged as an inflection point. We are at a huge point of previous support and resistance. Looking below, I have outlined a monthly chart dating back to 2014. We can see that this is where the stock came to rest after falling from $50 during the oil crash. This point has been tested multiple times going back. We are kind of at do or die here. The stock is either going to break through here, or come back down and move sideways like we saw it do from 2017-2019.

(Source: TC2000.com)

Below is a daily chart showing some of the more "recent" touches of the level we currently sit at.

(Source: TC2000.com)

So where to from here? As I said, it could go either way and that will largely depend on where the industry goes as a whole. Being bullish on oil & gas, I think it will break through and head for $6 which you can see below is kind of the next point of real resistance. With regards to sustained history that is. This would be a 25% move from current levels.

(Source: TC2000.com)

As for the potential downside, I look towards the 200-day moving average and ~$3.45. Not only is the moving average well off the stock as of right now, but it is also near a pretty crucial level of support going back over the last couple of years. One that the stock had a tough time getting over a couple of times in 2020 as well. This would be about 30% to the downside. As I said, I do think this would take some negative momentum from the industry and I do not expect to see that. But if this last year has taught me anything, it is that anything is possible.

Wrap-Up

As you can see, Southwestern is far from perfect. But I do believe they are saying the right things. Before I fully hop on board, I would like to see the stock break through that $4.85 level. If we get the positive energy environment I think we will, the company will be flush with cash and cut their leverage in half. Keep an eye on this name as the industry rebounds from this recent dip. In the meantime, stay safe out there!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SWN over the next 72 hours. 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.