Cabot Oil & Gas (COG, Financial) is a good stock in the oil and gas sector for several reasons. In YTD15, Cabot Oil & Gas has witnessed significantly volatility. The stock surged from $26.9 on March 10 to $35.4 by May 15. The 32% rally was driven by oil and gas prices trending higher during this period. However, with renewed pressure on energy prices, Cabot Oil & Gas has again slumped to $26.6. The stock has limited downside from current levels, and these levels are good for long-term accumulation. Some key long-term positive triggers will be discussed in this article.
The first reason to like Cabot Oil & Gas is the company’s focused operation in two assets that have proved to be game changers for many companies. Cabot Oil & Gas has 200,000 net acres in Marcellus Shale and 89,000 net acres in Eagle Ford. The company intends to drill 70 net wells in Marcellus and 45 net wells in Eagle Ford in FY15. This implies 60% capital expenditure allocation to Marcellus and 40% to Eagle Ford. Therefore, the capital expenditure program is high impact and focused on assets that have delivered strong results in the past.
The second reason to like Cabot Oil & Gas is the internal rate of return (IRR) potential for the company’s assets even in a low energy price scenario. The company’s Marcellus asset has an IRR of greater than 50% at $2.0 per Mcf realized oil price. Further, the company’s Eagle Ford asset has IRR in excess of 50% at $65 per barrel oil prices. Even at an oil price of $45 per barrel the IRR is 18%, and the oil price seems likely to average at least $55 per barrel in FY16. At $55 per barrel, the IRR is 38%. Therefore, even in a low-price environment, Cabot Oil & Gas can make strong investments and steadily increase production.
The company’s low-cost benefit is reflected in the operating cash flow for the first six months of 2015. For 1H15, the reported OCF was $439 million as compared to $585 million in 1H14. While OCF has declined, the downside has been protected by hedged positions and attractive IRR on assets. It is also important to mention here that Cabot Oil & Gas was not free cash flow positive for the first six months of FY15.
However, the company’s debt to capitalization was 48% as of 2Q15, and this gives the company flexibility to leverage. With the company having nearly $1.4 billion in revolving credit facility, the 2H15 investments and FY16 investments can be funded through internal cash flows and the available credit facility. In addition, the company’s adjusted EBITDAX of $483 million for 1H15 implies an annual EBITDAX of around $950 million, and this will ensure that the interest coverage remains strong.
It is important to mention that the company’s production growth guidance for FY15 is 10% to 18% despite a 45% reduction in drilling and completion spending for the year. I expect production growth to sustain in FY16 if there is recovery in energy prices in the last quarter of 2015 and first quarter of 2016. The reason for expecting production growth to sustain is the financial flexibility and significant drilling inventory at an attractive IRR.
Cabot Oil & Gas certainly looks attractive after the recent correction, and this is a good buying opportunity for long-term investors. The company’s assets have an attractive IRR and can deliver robust EBITDA and cash flow once energy prices trend higher. Small exposure to the stock is recommended since the near-term outlook for the sector still remain uncertain.
