In many respects, investors are going to find a lot similarities between companies like Ultra Petroleum (NYSE:UPL), Cabot Oil & Gas (NYSE:COG) and Range Resources (NYSE:RRC). Namely, that these are high-quality natural gas-oriented energy companies with attractive acreage and drilling prospects, as well as low operating costs. However, what is also similar between them all is the relatively low price of natural gas and the extent to which share price appreciation is going to be tied to improving natural gas realizations.
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Second Quarter Results Likewise Look Very Familiar
Range Resources had little problem increasing production for the quarter, as volume increased more than 50% if since-sold Barnett operations are excluded or about 42% if they are included. Oil and natural gas liquids production was less robust (up about 24% and 27%, respectively) and were a relatively small part of production, as natural gas made up about 80% of the total. Pricing continues to be challenging, with realizations down sharply (26%, with a 32% drop in natural gas).
However, the company continues to do relatively well with its costs. Unit costs rose about 11% per Mmcfe, with lease operating costs that still put it virtually at the top of the heap. Pre-interest cash flow (PICF) did decline slightly from last year, but grew about 13% from the first quarter.
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Big Plans Take Big Budgets
If there's a cause for concern at Range Resources (outside of more industry-generic issues like natural gas prices and environmental/permitting regulations), it may be with the company's capital budget and balance sheet. Range Resources has a very deep inventory of prospects, prospects that should offer strong economic returns, but the company's spending is running ahead of cash flow and the leverage (debt) is starting to pile up.
Range has been pretty willing throughout its corporate history to sell assets, particularly those that it sees as non-core and/or less economically promising, and I doubt that will change. The question is whether the company can really get fair value today on the assets it would rather sell than keep. That means the company is either going to have to pull back on its drilling programs (hurting production) or increase its leverage even further (increasing the risk) if it cannot improve its cash flow production and/or get a good price for those assets.
SEE: Oil And Gas Industry Primer
Liquids Will Help Some, but Don't Go Overboard
A lot has been made of Range Resources' prospects in more liquids-rich areas like the Southern Marcellus. To be fair, there may be some underappreciated value here, particularly as it pertains to the company's unusually high level of propane in the mix. That said, only about 21% of the company's reserve base is in liquids, and more of that is in the form of natural gas liquids than oil. So although more liquids development can sweeten the mix some, this is still a company that needs higher natural gas prices to work well as a stock.
The development of more export LNG terminals will eventually help shrink the differentials between today's U.S. natural gas prices and global prices, but that doesn't help much today, likewise with the M&A story. Yes, Range would be a good acquisition for any larger company that wants a high quality reserve base in the Marcellus, but few if any majors are openly discussing their interest in such expansion (likely, because management realizes that however sound of a long-term move that would be, analysts would likely rip them in the short-term).
The Bottom Line
Today, I'd personally rather own Cabot or Ultra Petroleum in the natural gas space, mostly because of the aforementioned concerns regarding the company's leverage. While the stock does not look especially compelling based on a nine times multiple to 2013 EBITDA, I don't think investors can really get a fair sense of the company or stock's value on that basis. Looking at the net asset value and considering a long-term environment where natural gas prices are higher, these shares are still worthwhile for investors who have the patience to wait for those better natural gas prices.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.