Company and Asset Overview
Cabot Oil and Gas Corporation (COG, Financial) is involved in the development, exploration, production and marketing of natural gas, crude oil and natural gas liquids in the United States. Two prime areas of focus for Cabot are its assets in Marcellus Shale and Eagle Ford.
The company has a very strong position in the Marcellus Shale with approximately 20,000 net acres in the dry gas window of the northeast Pennsylvania, and currently has six rigs operating in the region.
Apart from the Marcellus shale, Cabot also has rich assets in Eagle Ford, one of the biggest shale in North America. The company currently has approximately 53,000 net acres of assets with three rigs.
Strong Financials with Improving Cost Structure
Cabot has a good history of strong financials. Not only the financial statements, but both the cash flows and balance sheet are well managed. For me, gross, operating and EBITDA margins are best ways to determine and measure the company’s operating and cost efficiency.
I found that over the years in spite of economic uncertainties, the company has been able to maintain a high and consistent gross and EBITDA margin with considerable improvement in the operating margins.
If we look at the company’s last four quarter results, a high and stable gross margin of about 70% indicates the company is well positioned to meet its operating and other expenses. A high EBITDA margin indicates that less operating expenses are eating into the company’s profit.
Ă‚ | 2Q14 | 1Q14 | 4Q13 | 3Q13 |
Revenue | 533.2 | 509.8 | 487.5 | 435.9 |
Gross Profit | 406.6 | 384.3 | 369.3 | 336.2 |
Gross Margin | 76% | 75% | 76% | 77% |
Operating Income or Loss | 210.7 | 194.5 | 167.2 | 131.2 |
Operating margin | 40% | 38% | 34% | 30% |
EBITDA | 369.3 | 343.0 | 350.2 | 301.1 |
EBITDA Margin | 69% | 67% | 72% | 69% |
If we look at the company’s operating margin, it has increased from 30% in 3Q 2013 to 40% in 1Q 2014, an improving margin attributed to the company’s cash cost structure and decreasing finding costs. If we look at the company cost structure the company has been able to reduce its total cash cost from $2.12 in fiscal 2010 to an estimated $1.25 in fiscal 2014.
This reduction is primarily due to the presence of rich and very capital efficient assets of Marcellus Shale. Superior Marcellus assets have resulted in a decrease of finding and development costs from $0.63 per Mcfe in 2010 to $0.40 per Mcfe in 2013.
An improved cost structure has been a key driver for improved margins over the years. I strongly believe that the company would continue to benefit from its rich resources and yield better margins, and hence better returns to its shareholder.
Source: Investor Presentation
Production growth estimates
The company’s continued well performance improvement and better infrastructure projects visibility, coupled with natural gas demand in the near future, implies increase in production growth. This is also evident with an increase in the number of rigs with a plan to drill 110 – 120 net wells in 2014. In addition to this, the company’s plans to drill more than 60% of the Marcellus wells in 2014, which would further increase the operating efficiency and cost savings.
Also, considering the current drilling rates and more than 3,000 identified locations in the assets, Cabot has more than 25 years of inventory and this suggests reserve growth will continue to be high. I believe that a high capital allocation of about 73% of the company total capital program of 2014 will further add value to Cabot’s growth.
Continued performance improvement in Eagle Ford and a capital allocation of 25% of the total capital expenditure of 2014 suggests improved production growth here as well. From drilling activity of 23 net wells in 2012 to estimated 40-50 wells in 2014, I believe that the rich assets of Eagle Ford in South Texas would have a significant impact on the company’s production growth.
Thus, backed by 2014 total estimated net wells of 150-160, the company’s production growth is estimated at 28-41% in 2014 and 20-30% in 2015. I also believe that based on high exploration activity, reserves growth of the company would be robust for 2014 and 2015.
Attractive Valuations
Based on high growth production, analysts estimate earnings growth of 54% for fiscal 2014. Based on the current PE ratio of 33, the company is trading at 2014 PEG of 0.6, which suggests undervaluation. Further, the company is trading at an estimated 2015 EV/EBITDA of 6.8 compared to peers ONEOK Inc’s. (OKE, Financial) 12.7 and EQT Corporation’s (EQT, Financial) 7.3.
I believe that with strong growth prospects for next 2 to 3 years coupled with under valuation, Cabot Oil and Gas will continue to provide attractive returns to its shareholders.