- Coterra Energy delivered impressive results, with its adjusted EPS earnings increasing 173% y/y.
- Coterra Energy has one of the best balance sheets in the sector.
- Coterra Energy is approximately 25% hedged for 2022.
- CTRA stock is priced at 5x free cash flow, with 9.6% yield at current strip prices.
- As always, happy to discuss my thesis further in the comments section.
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Coterra Energy (NYSE:CTRA) is an E&P oil, natural gas, and NGL upstream company. Coterra announced its Q1 2022 results that simply outshone expectations. I had high expectations for this company going into print.
In fact, last month my article titled Huge Dividends Of 7.9%, Plus Large Buybacks, At 6x FCF demonstrated my bullishness.
It turned out that I was too conservative in my assumption. Indeed, it turns out that the business is in even better shape than I previously declared.
Consequently, I am now even more bullish on Coterra.
Why Coterra Energy? Why Now?
Coterra Energy holds upstream assets that engage in the exploration and production of oil, natural gas, and NGLs. In my previous article, last month, I went to great lengths to explain that the bear case against Coterra Energy had been that you don't invest in cyclical companies at low multiples.
To this effect, in the comments section, you can read people arguing that since the share price has risen so much so quickly, it must be overdue a pullback. And my question is why? It makes absolutely no difference whether the share price has come up a lot or gone down a lot.
All that matters is the following. Europe was fully reliant on natural gas from Russia and has massively underinvested in their own energy requirements.
Now, with Russian sanctions on the table, at a time when oil supply is heavily restricted, you are inevitably going to see a very favorable environment for oil and gas companies.
When investing, make your thesis as simple as possible. Don't try to overcomplicate the thesis to satisfy your ego. Focus instead on your wallet. Simple is better than complex. Don't try to jump over 7-foot hurdles; look for 1-foot hurdles.
Coterra's Q1 2022 Earnings Results Discussed
To give you an impression of how strong Coterra's prospects are right now, note the following. Last year, for Q1 2021, the combined company had a pro forma adjusted EPS of $0.37. This time around, Q1 2022 saw its EPS jump by 173% y/y to $1.01.
Investors are clamoring for growth stocks, right? Well, triple-digit growth, surely that's good enough? Not bad, for an old-economy stock?
In a moment we'll discuss Coterra's capital return program, but first, let's turn our focus to Coterra's balance sheet.
Coterra Has One Of The Best Balance Sheets In The Sector
What you can see above is that Coterra's net debt to EBITDAX is 0.4x. Not only is this meaningfully lower than the previous several years, but it's also a meaningful drop from 2021 too.
In other oil and gas cycles, when the boom periods come, these companies were so leveraged that it left them with no room to maneuver. However, as you can see above, this cycle is different.
It's survival of the fittest on ''fossil fuels''. After a multiple-year prolonged bear market, companies that wanted to survive had to make every conceivable cutback, downsize, and reduction in investment.
This meant that the companies that survived this period were forced to wholeheartedly embrace Lean operations.
Nevertheless, even with that consideration in mind, allow me to make this clear, Coterra has by some distance one of the best balance sheets in the sector. For shareholders, this is a very sweet position to be in.
Capital Return Program, 9.6% Dividend Yield, Plus Repurchases
As you can see in the graphic that follows Coterra expects a huge amount of free cash flow this year.
At the current strip price, Coterra guides for around $4.5 billion of free cash flows.
From that base, Coterra is committed to returning 50% of its free cash flow via dividends. This means that from dividends alone, going forward from the current market cap valuation, the dividend yield reaches around 9.6%.
Obviously, that's a really high yield. And that's why I put so much emphasis on Coterra's balance sheet in the previous section.
I wanted to drive home the point that it's not a leveraged play, where you get a high dividend, but you are buying a ticking time bomb.
The downside here is that nobody can forecast the price of oil. But Coterra's breakeven on the WTI is around $40. Given that prices for WTI are around the high $90s to low $100s, that means that there's a huge margin of error for shareholders before Coterra starts burning cash and incurring losses.
Next, I'll discuss its valuation.
CTRA Stock Valuation - Priced 5x FCF
Coterra is priced at around 5x this year's free cash flows. We can bring up the point that Coterra's book is roughly 25% hedged, and that is capping its free cash flows potential in 2022.
But let's not get too distracted here, right? 5x this year's free cash flow is cheap any way we look at it. And management clearly believes that to be the case too.
In fact, during Q1 2022, Coterra managed to repurchase around $144 million worth of its stock.
Accordingly, this means this past quarter alone Coterra returned to shareholders around 2.7% yield over a 90-day period. That's a seriously strong return over a short period of time.
The Bottom Line
Coterra is an oil and gas company that's very well positioned to benefit from high energy prices. The business holds a very strong balance sheet, with net debt to EBITDAX leverage of 0.4x.
Given the high strip prices, together with its strong balance sheet, Coterra is now oozing free cash flow and returning it to shareholders.
At the current rate, shareholders could get a 10% yield, without taking on too many risks. Even when oil prices turn south again, and the yield reduces from 10% at present, remember that the business has a breakeven price of around $40 WTI. Thus providing shareholders with an ample margin of safety.
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This article was written by
Michael Wiggins De Oliveira is an energy specialist whose primary focus is capitalizing on “the Great Energy Transition” - the confluence of decarbonization, digitalization with AI, and deglobalization - to achieve greater investment returns. Through his 9+ years analyzing countless companies, Michael has accumulated outstanding professional experience in the energy sector and a following of over 40K on Seeking Alpha.Michael is the leader of the investing group Deep Value Returns. Features of the group include: Insights through his concentrated portfolio of value stocks, timely updates on stock picks, a weekly webinar for live advice, and "hand-holding" as-needed for new and experienced investors alike. Deep Value Returns also has an active, vibrant, and kind community easily accessible via chat. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.
Michael is long VET and AR.
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