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Ruane Cunniff’s Long-Term Oil and Gas Pick

April 23, 2014 | About:

The oil and gas industry is said to find its greatest downside to a long-term investment on price volatility. Whether this is a myth or a partial interpretation of the events that led to price swings is an issue to discuss. In other words, the price changes experienced by the industry are real, but they must be interpreted in order to understand the reasons for them. For example, since 2008 gas prices experienced a deep decline until 2009, from then on changes in price are smooth. Something similar happened to crude oil prices, which experienced a sudden recovery and a smooth performance ever since. The decline is related to the economic crisis started in 2007, but the prices for both commodities were abnormally higher due to the constrained supply and political instability in the Middle East, aggravated by a silent resource competition between the US and China. Hence, price volatility is somewhat of a myth and Range Resources (RCC) may just be the right investment in the industry.

Improving Performance, and Expanding International Presence

For fiscal year 2013, Range Resources reported a record annual average daily production of 940 million cubic feet of gas equivalent per day and a cash flow of $943 million, an increase of 25% year-over-year for both indicators. Most important for a company in the oil and gas industry, Total proved reserves increased by 26% to 8.2 trillion cubic feet equivalent, and a reserve replacement ratio of 612% at $0.61 per million cubic feet equivalent, figures backed by a net income of $116 million versus $13 million in 2012, representing a 792% increase.

Performance results for Range Resources, however, have not translated into positive reviews by analysts. Throughout April, only one financial institution has neutrally rated the stock, while Barclays rated it “Underweight” and Deutsche Bank boosted the target price. Additionally, there is a wide gap separating the target price published by the three financial institutions. There is a $23 difference between the lowest and highest proposed value, making the recommendations somewhat useless for any prospect investor.

Nonetheless, Range Resources continues to expand its activities. Management has recently announced the boosting of production at the Marcellus Shale, at the same time raising capital investment by $220 million when compared to 2013. Also, a memorandum of understanding has been signed with one of China’s largest listed oil service companies for a strategic alliance, while continuing efforts on the buildup and development of assets in Trinidad. However, the company is under the eye of the Environmental Protection Agency, in relation to a suspected leak at a water waste deposit in Washington County.

Hidden Grim Prospects

Throughout the last three years, Range Resource’s overall performance has improved. Revenue and net income are on the uptrend; however, gains are questioned by an ignored rising debt. Meanwhile, operating margin entered a strong uptrend in the same period, finding a ceiling on the high-teen during the last two years. Hence, the indicator remains well behind the value reached on 2008. Most important, 2013 registered no insider purchases and a great number of sales, giving some insight into what is expected from the business in the coming years.

Range Resources has some positive characteristics. The business model constructed a diverse portfolio, spread between low-risk long-reserve-life assets and large-volume-rapid-payout properties. However, there are many downsides to the business. First, prospects are closely linked to the successful completion of undergoing projects. Second, it requires more capital and new high-pressured lines to gather gas at the Marcellus shale due to over-pressure. Third, the absence of beneficial partnerships or disposal of low-profit generating assets. Fourth, capacity is due to encounter a bottleneck as reserves grow unmatched by processing assets.

Trading at 131.6 times its trailing earnings, Range Resources carries a 350% premium to the industry average. Also, quarterly dividend payments stand at a low $0.04, representing a 0.17% annual yield. In short, at this time benefits are greatly behind the cost of investment. For the same reason, the stock is not recommended for a long-term investment.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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