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RS Investment Management’s Exploration & Production Pick

May 03, 2014 | About:

Growing global economic recovery continues to place oil and gas explorers and explorers under pressure. Although recovery across the globe is unequal, energy demand rises steadily. While the most dramatic change in indicators has been recorder for North America, Europe struggles to find its north. Meanwhile, the Chinese economy returns to normal growth indicators. In addition to the pressure from developed economies over energy supplies, the Middle East and Africa fall prey to political uncertainty, scaring away foreign investors. The so called Arab Spring, and continued attacks to assets located in Africa, left many energy producing countries out of the business momentarily. Hence, others regions became more attractive as the proper equipment became available. For example, shale reserves in the US or Argentina. And, even the Chinese government took interest in the exploration of unconventional reserves. One company with important presence in North America is Cabot Oil and Gas (COG).

Growing Reserves and Performance

A key element for determining any growth prospects for an exploration and production company, is the reserve replacement ratio. Cabot Oil and Gas reported year-end proved reserves of 5.5 trillion cubic feet equivalent, an increase of 42 percent over year-end 2012. "This level represents a doubling of our proved reserves in just three years from a 100% organic drilling program, despite an active divestiture program that has seen 380 billion cubic feet equivalent removed during this time period," stated Dan O. Dinges, Chairman, President and Chief Executive Officer.

When looking at the financial performance, Cabot Oil and Gas reported record production of 413.6 billion cubic feet equivalent for 2013, an increase of 55 percent over 2012. Moreover, cash flow from operations reached $1.025 billion, for a total net income of $279.8 million, or $0.67 per share, an increase of 112 percent, year-over-year. Also, the company received approximately $324 million of gross proceeds from non-core asset sales, used in conjunction with cash flow from operations, to fund a $1.195 billion capital expenditure and $165 million share repurchases.

Five financial institutions reported on Cabot Oil and Gas during the last month. Two of them have downgraded the stock to “Hold,” while the remaining three upgraded the stock to “Buy.” Target price however, remains above the $40 mark. Moreover, during the current year only a total of three institutions have downgraded the stock. Most important is the good humor surrounding the stock’s performance and prospects.

Pricing Is the Key

The balance of the first quarter of 2014 for Cabot Oil and Gas confirms the good moment. Production climbed to 119.9 billion cubic feet equivalent, and discretionary cash flow reached $319.5 million, respectably totaling an increment of 34% and 36% over last year's comparable quarter. Hence, the company has been able to increase production and profitability amid unscheduled downtime of compressor stations for operations at the Marcellus Shale. Most important, a new rig will be added to the Eagle Ford operations during the third quarter.

Looking forward, Cabot Oil and Gas reported the execution of a definitive gas sale and purchase agreement with a subsidiary of WGL Holdings (WGL), and the execution of a binding precedent agreement with Transcontinental Gas Pipe Line for a new pipeline with committed takeaway capacity from the owned asset in Susquehanna County, Pennsylvania. Most important, it holds a diversified asset portfolio spread between low-risk and long reserve-life Appalachian assets, and large-volume and rapid-payout Gulf Coast properties, with further variety from large prospect inventories in the Rocky Mountains and the Anadarko Basin that have a broad mix of production and payout profiles.

Currently, Cabot Oil and Gas trades at 47.4 times its trailing earnings, carrying a 67% premium to the industry average. Moreover, the company maintains a stable balance sheet that will continue to provide the flexibility to fund its capital program and pursue bolt-on acquisitions. Also, it pays $0.02 in quarterly dividends for a total annual yield of 0.15%. Given the small reward, it is not recommended to follow on the steps of RS Investment Management (Trades, Portfolio) and Daniel Loeb (Trades, Portfolio). And prospect investors should look for a better priced option.

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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