Will Cabot Continue Shining in '12?

Zacks

Houston, Texas-based Cabot Oil and Gas Corp. (COG) is an independent energy exploration firm with producing properties mainly in the U.S. Founded over 100 years ago in Pennsylvania, Cabot originally operated in the Appalachian Mountains of the eastern U.S. before moving the bulk of its activities to the Gulf Coast.

Presently, the company has four domestic focus areas: the Appalachia, the Gulf Coast, the Rocky Mountains, and the Anadarko Basin (in Oklahoma, Kansas, and the Texas Panhandle). As of year-end 2010, Cabot had 2.70 trillion cubic feet equivalent in proved reserves (98% natural gas). The company produced 130.6 Bcfe of oil and gas in 2010, of which more than 96% was natural gas.

Top 2011 S&P Stock

Despite being a somewhat unfamiliar name, this natural gas producer was the best performing stock for 2011, gaining almost 100% during the year. Opening at $38.25 in January, Cabot rose 98% to end the year at $75.90, down from its high of $90.00 in November. The S&P 500 component defied weak natural gas prices to set a scorching pace in a year that saw the overall index ending down 0.6%.

The question is: why did the Cabot stock skyrocket when the oil service sector index declined more than 11% in 2011 and natural gas prices fell approximately 30%?    

Increased Output & Other Catalysts

Natural gas firms like Cabot have been able to drum up investor attention mainly because of their ability to boost production.

Cabot’s Marcellus program continues to ramp up with exceptional results (with current field production of 517 million cubic feet per day). As of now, the company has nearly 200,000 acres under lease in the play, and it continues to expand. In the Eagle Ford Shale play, where Cabot has partnered with EOG Resources (EOG), the company controls 60,000 net acres and has a total of 21 producing wells. We believe the company’s Marcellus and Eagle Ford production will ensure 2012 volume growth beyond the currently guided target of 45-55%.

Cabot's diversified asset portfolio is spread between low-risk/long reserve-life Appalachian assets and large-volume/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.

Cabot has hedged more than a third of its projected 2011 production at attractive prices. This lowers the company’s near-term commodity-price exposure, which is a key positive for Cabot’s risk profile, given the current market concerns.

Unfortunately, Cabot’s Spectacular Run May Hit a Speed Bump

There is no doubt that 2011 was a golden year for Cabot but we do not believe that the stock will be able to sustain the momentum in the near future.

First of all, some of Cabot’s 2011 gains could be tied to takeover rumors that grew following the Anglo-Australian mining giant BHP Billiton’s (BHP) July announcement to purchase fellow shale gas producer Petrohawk Energy Corp. for $15 billion.

Secondly, while the company’s total revenue and profit are still expected to go up despite falling natural gas prices, Cabot’s steep valuation – currently selling at 62 times 2012 estimated earnings – and miniscule payout, keep us worried. We attribute the jump in the company's share price to future speculation rather than current operating results.

Finally, Cabot has often run into trouble with state regulators. The driller has been sued by 15 families in Pennsylvania, with accusations of drinking water contamination.   

Given these concerns, we expect Cabot to perform below its peers and industry levels in the coming months. As such, we see little reason for investors to own the stock. Our bearish stance is supported by a Zacks #4 Rank (short-term Sell rating).

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