Among oil and gas stocks, there are several companies that are overleveraged and can be avoided at a time when oil prices remain at lower levels. There are other companies that are not so significantly leveraged and have some excellent low break-even assets. My focus is on the second type of companies and stocks as these are worth accumulating at a time when overall market sentiments are depressed. This article discusses one such stock, that is currently trading at attractive levels and can generate strong returns with a 3-5 year investment horizon.
Cabot Oil & Gas Corporation (COG, Financial) is an independent oil and gas company that explores, produces and markets natural gas, oil and natural gas liquids in the United States. As of December 2014, the company had 200,000 net acres at Marcellus Shale and 89,000 net acres at Eagle Ford Shale. Further, as of FY14, the company had proved reserves of 7.4Tcfe and a long-term drilling inventory.
Coming to the reasons to be bullish on Cabot Oil & Gas, the first point is the company’s excellent assets that have a low break-even. This is a critical point and worth discussing first as lower oil and gas prices implies that lower break-even assets can still generate profitability. For Cabot Oil & Gas, the Marcellus Shale assets have around 80% IRR at $2.45/Mcf realized price and 50% IRR at $2.0/Mcf realized price. Therefore, low break-even assets can continue with a robust production profile even at current gas prices.
Further, the company’s Eagle Ford Shale asset has 20% IRR at $55 per barrel realized price. I do believe that the company will exploit its oil assets significantly only when oil prices recover. However, even at current production levels, the company will not be running at a loss considering the point that EIA estimates 2015 oil price to average $60-$70 per barrel.
Considering both the points above on the break-even levels for the two assets, it is not surprising to see that Cabot Oil & Gas has estimated a production growth of 10% to 18% in FY15 as compared to FY14. While the company’s capital expenditure for the year will be only $900 million and the number of wells to be drilled is estimated at 115 as compared to 177 in FY14, a production growth of 18% on the higher side will still be robust considering the challenging times faced by the industry.
I talked about leverage at the beginning of the article and I would like to mention here that Cabot Oil & Gas has a net debt to EBITDAX of 1.2 as of FY14. Therefore, the company is not highly leveraged and a capital expenditure of $900 million for 2015 implies that leverage will remain in control in this year as well as internal cash flows will fund most of the capital expenditure. Further, the company has $1.3 billion in undrawn revolving credit facility and this implies that the company is fully funded for 2015 even from a debt perspective.
From a long-term perspective, the low-cost assets will seem even more attractive when oil and gas prices trend higher. While oil and gas prices might not move significantly higher in 2015, a strong upside can come over the next 2-3 years. As of December 2014, Cabot Oil & Gas had 3,000 potential drilling locations in the core of the dry gas window of the Marcellus Shale and over 1,300 locations in Eagle Ford Shale. Therefore, the long-term drilling inventory is significant and the company is likely to significantly ramp-up its capital expenditure once oil prices recover.
In conclusion, Cabot Oil & Gas is certainly worth considering at current levels for its excellent low cost assets, significant drilling inventory, low leverage and a strong operating history. In my view, the stock can be an outperformer in the oil and gas space considering a 3-5 year investment horizon.
