CNX Resources: The Red-Headed Step-Child Of The Marcellus

Summary

• CNX has underperformed its competitors in the last year and a half.
• A massive share repurchase and continued tightness in gas supplies could be a catalyst for growth.
• We are moving from bearish to bullish on CNX.
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Introduction

CNX Resources, (NYSE:CNX) is the Rodney Dangerfield, of the gas "bidness." Like Rodney, it "can't get no respect." Since my last article in May there have been no new articles on the company, so I thought I would take another look. I was bearish at the time of that last article, and I was more or less right. The stock's dropped into the $10's during the intervening time and then rebounded to nearly $16. What's an investor to think?

WSJ

Analysts are split with an average estimate of $19.45, and an upward outlier of $28. That's quite a range with a 25% upside at one end, and a near double on the other. In this article will review key elements of CNX's third quarter, judge what they tell us about the direction the stock may take as we head into winter.

We will also discuss an internal catalyst that might change the dynamic for CNX. The company is set to reduce their float by up to 40%, which should be bullish for the shares.

The thesis for CNX

Before I figured out that offshore was a much better life than onshore, I used to travel lease roads in western Oklahoma and Texas, chasing drilling rigs. Fann-35, vis cup and funnel at the ready. These roads shared one thing in common. They were flat and seemed to stretch to infinity before T-boning into another one and then stretching to infinity in that direction. Shimmering in the distance-often 10-15 miles away, was the rig enticing me on. I could see it the whole way, no matter how many 90 degree turns I made. Not so with lease roads in the Marcellus. Talk about a crooked mile!

I happened to drive diagonally through Pennsylvania on the way back to Mississippi, after a New England holiday last week. Right through the heart of the Marcellus. I remember thinking as I admired the natural beauty of this state, "Darn, I am glad I didn't have to make rig calls around here." I didn't see a single rig in the mountainous terrain, although as a writer of the fortunes of the energy companies that drill up there (relative to Mississippi, right?), I knew they were out there...somewhere. (Hopefully not taking a kick while waiting on a drive by.)

Enough reminiscing, on to business.

Gas is a popular topic these days around the virtual water coolers of the world. Wait... that's not right... it's the price of gas that has folks lingering at the water tap, wondering if they'll have to get a bump up in their HOMEC to pay the heating bill this winter. That and concerns about the availability of this much maligned, but critical resource, are driving the conversation. This tends to have what I like to call a "knock-on-effect" for those are who in the business of drilling and producing it. For most companies anyway. EQT Corp, (EQT) which we discussed recently is a great example of a company whose fortunes have tracked those of gas.

CNX has struggled as I noted above. I discussed some of the reasons in the last article. Now, you don't have to be Sherlock Holmes to figure out what has put a drag on the stock since earnings were released. Hedging to the tune of about ($1,376 mm) that went against them, and the volumes-about 94% of their 2021 production, have helped to put a kibosh on the stock. I am not going to club them for this practice as it is pretty common for gas producers to put a floor price on their production to ensure they can meet their obligations.

Don Rush CFO, comments here defending their hedging philosophy-

We view our hedging philosophy is right way risk mitigation, meaning that our free cash flow and capital investments are protected should prices fall for a few years. And on the opposite side, if we have to though, a mark-to-market loss on our hedge book, that means the future annual free cash flow generation of the company has actually increased as we still have a significant open volumes in the future.

Source

Essentially they are willing to sacrifice potential upside to ensure they make a steady predictable return. I suppose if gas prices were still sub-$2.00 we'd be patting them on the back.

Seeking Alpha, Chart by author

Range Resources, (RRC) and Antero Resources, (AR) are the multi-bagger winners here. We wrote up RRC last August and recommended jumping in below $7.00. AR got by us, and mores the shame with the run it's had. Apache Corp, (APA), and EQT Corp have also out-performed CNX, although they had hedging issues of their own.

The buy thesis for CNX would be several-fold at this point. One, winter hasn't really hit yet, so we don't know how much pressure is going to be put on marginal storage volumes. It's anybody's guess at this point. Two, the other guys are pretty richly valued with price to OCF's in the 10-11X range, and could be within a few bucks of their peak. Here's CNX sitting at a 6-7X, so there's some room to rise.

And, finally as we saw with EQT, with CNX's low costs-$1.06/MCFe against a realized prices after hedging of $2.69 MCFe, they are still raking in a ton of money. That's what capital efficiency gets you.

There's also the potential stock repurchase catalyst that could shrink the supply of the stock and push the price higher.

Q-3

Well if it wasn't for that darn hedging loss, I think we would see some very different sentiment toward CNX, and we wouldn't be trying to evaluate if the current price is a bargain, or just an extension of the value trap it's been.

Source

The CNX balance sheet is in pretty good shape. They've used cash to pay down debt, with a line of sight to a 1.5 leverage ratio. They've bought back shares at a price point where it makes sense to be doing this, and plan to buy more to the tune of $1.0bn.

They are generating cash and it looks like the hedged volume has been reduced for 2022, so further cash flow should be in the offing. They are not releasing guidance, so the exact amount can't be determined. I took this from a comment in the call.

Nor are they going to go crazy with capex to field an aggressive drilling program. An article in Platts note the fairly tight band between 32.5 and 34 BCFD for Marcellus gas this year, even as prices have risen from the low $2's to the high $5's for Eastern Basin gas this year. Nick Deluliis, CEO of CNX knocked any idea of funneling new capital into drilling to take advantage of current pricing, right on the head-

I think we stay within that one rig, one frac crew operating plan for the foreseeable future.

Source

A possible catalyst for CNX

I think valuation is the key here. So many of their competitors have run hard and multiplied their capitalization by 5-7X, that it gets hard to buy into their story continuing much higher... unless you believe $6.00 gas is here to stay. For reference the NYMEX strip has it back just above $4.00 MCF by April next year.

That's still pretty good money and the share buyback potential catalyst is the icing on the cake. Nick Deluliis comments on their bias toward share count reduction-

The free cash flow allows for capital allocation opportunities we were primarily focused on balance sheet strengthening and share count reduction. Q3 was a good example of this, approximately 60% of our free cash flow was returned to shareholders in the form of buybacks, and most importantly at discounted prices.

Source

Risks

A speculative play like CNX carries risks. They have a billion dollars of authorization to buyback stock, but nothing compels them to do so. If they don't follow through or stage purchases to maximize shareholder returns, then that leg of the CNX thesis weakens. That said, the management of CNX is decidedly in favor of this strategy, so I don't see this as big risk.

There is also the risk that gas prices could crater. Despite the hedging plan so clearly articulated in the call, a collapse in the commodity would take the shares down considerably. The NYMEX strip is a guide, and not a certainty.

Your takeaway

There's a lot to like about CNX as we head into winter, starting with the price point. If they go through with that $1.0bn share repurchase, and assuming the price doesn't rise dramatically, it equates to about a 40% reduction in their current float of 218 mm shares. That's bullish. If you divide their current valuation into a share count of ~130 mm, you come up with a share price of $24, or about 40% above current prices. That's an over-simplified calculation, I understand. The point is there are at least a couple of reasons for the share price to rise in the present market.

Finally, the gas market has changed since our last bearish article on CNX. In May there was still some doubt about the pricing levels gas would reach and we suspected the market would punish CNX, as it has, for the hedging losses. Hence the bearish viewpoint in addition to the pad spacing argument I advanced in May. Instead the tightness of supply narrative has won the debate and pumped up the price of gas to near decade highs, along with the stock prices of many gas drillers, save one. I circle back to ways to play the strength in gas at a discount at this point in the cycle. CNX could be just the ticket.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in CNX 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.

This is not advice to buy or sell this stock or ETF. I am not an accountant or CPA or CFA. This article is intended to provide information to interested parties and is in no way a recommendation to buy or sell the securities mentioned. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to do their own due diligence before investing their hard-earned cash