U.S. Markets closed

Cabot Oil & Gas Is a Potential Value Creator

- By Faisal Humayun

The oil and gas sector continues to navigate through challenging times, but there are some excellent long-term investment opportunities. Based on the first-quarter results and the potential outlook for the rest of fiscal 2017, I have been writing about some names in the energy industry that could witness strong stock action in the near future.

Cabot Oil & Gas (COG) is an independent oil and gas company engaged in the development and exploration of oil and gas properties in the continental U.S. The stock has returned 3% year to date; even for the last 12 months, the stock has been sideways. I see this consolidation zone as a good opportunity to accumulate it for the next 12 to 24 months.


Fundamentals remain strong

As there is gradual recovery in the industry, it is important to discuss the company's fundamentals coming out of the crisis. For Cabot Oil & Gas, fundamentals have improved significantly; that will help the company ramp up investments as the industry witnesses relatively good times.

To put things into perspective, the company's net debt to LTM EBITDAX was 2.5x as of fiscal 2015; for the first quarter, the company's leverage declined to 1.3x. With net debt to capitalization of 26.6%, Cabot Oil & Gas has sufficient financial muscles for growth.

Another important point to note here is that Cabot Oil & Gas targets fiscal 2017 E&P expenditure of $845 million. The company had cash of $500 million as of March 31 and for the first quarter the company reported operating cash flow of $270 million. Considering the same OCF for the remaining quarters, the company is positioned to report cash flows of $1.1 billion to $1.2 billion for fiscal 2017.

This would imply that the capital expenditure can be met through cash flows and the company's cash buffer would also swell. Even if the same level of cash flow is assumed for fiscal 2018, Cabot Oil & Gas is fully funded for investments in the next 24 months without an increase in debt.

Improved price realization to sustain

It is important to note that for the first quarter, Cabot Oil & Gas reported healthy EBITDAX and discretionary cash flow numbers. This has primarily been on the back of improved realization for oil and gas.

Just to put things into perspective, realized gas price for the first quarter was $2.65/Mcf (excluding hedges) as compared to $1.49/Mcf in first-quarter 2016. Similarly, realized oil price for the first quarter was $46.7 (excluding hedges) as compared to $27.7 in first-quarter 2016.

The positive momentum in energy prices is likely to sustain even as there has been some correction in prices recently. Even if oil trades at $55 to $60 per barrel in the next 12 to 24 months, I see decent cash flows for Cabot Oil & Gas. Even for gas prices at first-quarter realization levels, Cabot Oil & Gas is positioned to deliver positive free cash flows.

Another factor worth noting after first-quarter results is that Cabot Oil & Gas has increased production guidance from a range of 5% to 10% to a range of 8% to 12%. Therefore, besides higher price realization, the company also stands to benefit from volume growth.

From a volumes growth perspective, the company's oil volume growth is expected to be 15% for fiscal 2017. However, 2017 exit-to-exit oil production growth is expected to be 50%. In the coming years, I expect gradually increasing weight toward oil in the production profile and that can potentially expand the EBITDA margin.

Conclusion

Cabot Oil & Gas also increased its quarterly dividend by 150% in the first quarter to 5 cents per share. Dividends will increase in the coming quarters with the company having strong financial muscles. This is another factor that will result in stock re-rating.

While broad markets are trading at a premium, there are reasons to be cautious. However, value buys are available in all market scenarios and Cabot Oil & Gas is certainly appealing at current levels.

Disclosure: No positions in the stock.

Start a free seven-day trial of Premium Membership to GuruFocus.

This article first appeared on GuruFocus.