EQT: Holding Up Progress

Summary

• Secondary common stock offerings will temporarily depress the stock price.
• The market to market hedging losses cloud the progress that management has made.
• Those mark to market losses are an opportunity loss of the ability to sell the natural gas for a better price.
• The company actually breaks even or makes money on natural gas sold at the hedge price.
• Management has made some good acquisitions while decreasing operating costs that will make for a far better future.
• This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »

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Recently EQT (NYSE:EQT) announced another secondary offering by selling shareholders. The market has to absorb that additional stock before the stock price moves forward. This represents a risk of using equity to finance transactions. Oftentimes, the buyers want to sell the stock fairly quickly to realize the cash that the sale was intended to raise in the original transaction.

Further muddying the otherwise optimistic outlook is the announcement of large mark-to-market hedging losses. But those losses represent an opportunity cost. Without the hedges, management would have gotten more for the natural gas than with the hedges. The amount reported is the opportunity lost through the hedging process.

In return, most companies report somewhat less volatile earnings that would be the case without the hedging. For some managements, the hedges are used to justify the returns earned by the capital budget. Those managements are looking for certainty of a return in exchange for an unexpected price rally (like we have now).

On the other hand, the stock price should be aided by the initiation of a $.125 per share quarterly dividend and an optional stock repurchase program. The mark-to-market hedging losses are opportunity costs that do not reflect an actual reported cash loss. The company generates decent cash flow even though the selling prices are below the market price because of the hedges. The initiation of the dividend and the stock repurchase agreement may help the market understand the rather complex situation. What is hidden by GAAP accounting is that the company operations likely made money before the reported hedging loss. At the very least, the company actually lost nothing close to the reported hedging loss because it is not an actual loss as most shareholders would understand the loss.

The other thing that is keeping the stock price stuck in a trading range is the need to assimilate the acquisitions made and optimize the overall operations. There will be a fair amount of one-time expenditures that will likely recede as the current fiscal year progresses. The next fiscal year will likely be a far better indication of the cash generating capability of the company because there will be less nonrepeating items reported quarterly.

In the meantime, shareholders need to be patient to give the company time to show the benefits of the latest acquisition strategy. Large acquisitions often have more daunting combination characteristics even if they are bolt on. The logistics remain challenging. For that reason, many large acquisitions do not fulfill the original goals of management.

This management appears to be more detail oriented than most. That is the kind of characteristic that often enables large acquisitions to succeed.

EQT Third Quarter 2021, Cost Summary.

EQT Third Quarter 2021, Earnings Press Release

One of the more interesting items is shown above. Despite the acquisitions made, the continuing "cash costs" as well as some other important costs remain lower than they were a year ago. That is extremely encouraging because it is evidence of very tight management control in the face of major business additions.

Management is also tightening up on the administrative side while the use of equity has helped to bring down the interest costs per unit as shown above.

Now some of the acreage acquired has more liquids production than did the company before the acquisition. With that acreage the major goal will likely be to maintain the costs shown above where possible while gaining margin from the additional value of liquids produced. That would enable profitability under a greater range of industry pricing scenarios.

Income Statement Summary From The Third Quarter 2021, EQT Earnings Press Release

EQT Third Quarter 2021, Earnings Press Release

The above chart amply demonstrates that the business is making solid progress despite the pricing limitations of the hedging program. Some of the smaller adjustments are definitely subjective. But what cannot be argued is that management has done a tremendous job of decreasing costs to the point that this company will make money at prices lower than many thought possible.

The addition of liquids production will mean that the company (and wells) breakeven will adjust based upon the pricing of the liquids as well as the natural gas prices. It is a very fluid multi-dimensional pricing matrix rather than just natural gas prices. That will make it harder for the market to analyze. But it is likely to make the company more profitable as long as management maintains that tight control of costs as liquids production increases.

Line Of Sight For Investment Grade Rating

EQT Corporation Third Quarter 2021, Earnings Conference Call Slides

Management is still working to decrease interest costs and operating costs. The debt due profile has improved tremendously. Should the cash flow of the company approach anything close to what management aspires to after the acquisitions, then the debt due in the near future will not be an issue. There is a very good chance that this company will achieve an investor grade debt rating. At that point debt financing becomes a far less arduous task and far more cost effective.

Our Modern Model Has Driven A Step Change In Asset Performance

EQT Corporation Third Quarter 2021, Earnings Slide Presentation

This slide helps to clarify a very common misconception. New wells at lower costs and higher reserves due not materially impact results until there are enough of them. Therefore, reported results nearly always lag cost improvement announcements significantly when it comes to finding and development costs.

This kind of improvement can also have a delayed effect on some lease operating expenses as well. But depreciation is more likely affected by the lower of cost or market calculation than it is by this type of improvement. The reason is that the steady progression of technology to lower costs often means that older wells are under-depreciated. That often gets fixed during a market downturn.

So, what is left is for all of the improvements of management combined with the acquisitions to show enough benefits to send the stock price higher. The latest secondary sales are delaying any immediate stock price improvement. But the promise of all of management's moves is still there.

There may be some institutions that get tired of waiting. But investors often are far more patient than their educated brethren. Far too many studies have demonstrated that for decades. The good news is that as large shareholders sell, it leaves more room for other large shareholders to buy (and push up the stock price) when the improved results begin to be reported.

As was shown above, results are already beginning to improve. Those results are hidden by the recording of a "never cash" opportunity cost of mark-to-market hedging. Eventually the hedging program should adjust to the current market conditions.

The current natural gas pricing rally has caught a lot of managements by surprise. But the better prices appear to be here to stay as North America joins the world natural gas market through the growing ability to export natural gas. That realization should sharply improve the future outlook of this company.

Returning Capital And Starting To Reduce Debt

EQT Corporation 2022 Goal Presentation

Management has stated some ambitious goals for fiscal year 2022. These are made possible by the current robust outlook for commodity prices. The warning about that great outlook is this is one very low visibility industry. So that outlook can change considerably should an unforeseen price decline occur. In the meantime, there appears to be a tremendous amount of operating leverage that should become apparent to the market in the current fiscal year.

Disclosure: I/we have a beneficial long position in the shares of EQT either through stock ownership, options, or other derivatives. 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.