On Feb 5, 2013, we downgraded natural gas producer Ultra Petroleum Corporation (UPL) to Underperform from Neutral, concerned by the current weak sentiment for the commodity.
Why the Downgrade?
The glut in domestic gas supplies continues to weigh on the fundamentals, and storage levels remain well above their benchmarks. This translates into a bearish near- to medium-term outlook for natural gas-weighted companies like Ultra Petroleum.
Causes for Concern
Ultra Petroleum’s high natural gas exposure raises its sensitivity to gas price fluctuations, compared to its more-diversified independent peers with higher oil production. The company, which derives more than 95% of its reserves/production from natural gas, has seen its sales and income fall drastically in the recent quarters on the back of a sharp drop in gas prices.
The grossly oversupplied market continues to pressure commodity prices in the backdrop of sustained strong production, forcing Ultra Petroleum to announce drilling curtailments and drastically slash development drilling investment. While subscribing to management’s outlook, we believe the realignment of Ultra Petroleum’s strategy will take some time to bear results and we expect the company to continue to struggle unless the outlook for natural gas prices improves.
Ultra Petroleum currently generates substantially all of its revenue, earnings and cash flow from activities in its Pinedale and Jonah fields in Wyoming. Consequently, any significant downtime related to pipelines or processing plants in the region could affect the company’s results.
Stocks That Warrant a Look
While we expect Ultra Petroleum to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at Breitburn Energy Partners L.P. (BBEP), Cabot Oil & Gas Corporation (COG) and Memorial Production Partners L.P. (MEMP) as excellent buying opportunities. These domestic energy explorers – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.
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