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Tickers in this Article: SWN, CHK
Independent natural gas operator Southwestern Energy Co. (SWN) reported second-quarter 2012 earnings of 26 cents per share, at par with the Zacks Consensus Estimate. The quarterly result, however, declined 45.8% from the year-earlier profit of 48 cents. The underperformance was primarily due to the drop in natural gas prices.

Second-quarter revenue declined 21.6% to $599.7 million from the year-ago level of $765.2 million. The revenue also lagged the Zacks Consensus Estimate of $641.0 million.

Production and Realized Prices

During the reported quarter, the company's oil and gas production grew nearly 12% year over year to 137.4 billion cubic feet equivalent (Bcfe) - almost entirely gas - driven by the Fayetteville Shale operations. Production from Southwestern's Fayetteville Shale play increased nearly 13% to 121.0 Bcfe from the year-earlier period.

The company's average realized gas price, including hedges, dropped more than 27% to $3.12 per thousand cubic feet (Mcf) from $4.30 per Mcf in the year-ago period. Oil was sold at $104.44 per barrel, up 4.1% from the year-earlier level of $100.32 per barrel.

Segmental Highlights

Operating income for the Exploration and Production (E&P) segment dropped nearly 66% year over year to $76.0 million in the second quarter. The decrease was due to lower gas price realization as well as increased operating costs and expenses related to higher production, partially toned down by the increased output level.

On a per-Mcfe basis, lease operating expenses were down by a penny at 79 cents versus 80 cents in the prior-year quarter. On the other hand, general and administrative expense per unit of production was same as the year-ago level of 27 cents.

The Midstream Services segment's operating income jumped more than 20% to $71.8 million in the second quarter from $59.6 million in the year-earlier quarter. The increase was driven by an improvement in gathering revenues related to the Fayetteville and Marcellus Shale plays.

Capex and Debt

The company's total capital expenditure in the quarter was $588.6 million, of which $531.8 million was invested in E&P activities and $47.7 million in the Midstream segment.

As of June 30, 2012, long-term debt stood at $1,668.8 million, representing a debt-to-capitalization ratio of 32.2% (versus 28.7% in the preceding quarter).

Hedging

At June 30, 2012, Southwestern had approximately 134 Bcf and 185 Bcf of its 2012 and 2013 expected gas productions hedged at an average floor price of $5.16 and 5.06 per Mcf, respectively.

Guidance

Earlier, Southwestern had updated its production guidance for 2012 to the range of 560 Bcfe to 570 Bcfe. The outlook represents a 13% increase over the 2011 level.

Our Take

Southwestern's industry-leading holdings in Northern Arkansas' Fayetteville Shale play make it one of the highest quality natural gas discoveries in North America in recent years. Marcellus and Fayetteville shales also hold ample opportunity for newer natural gas discoveries.

We see the company as well positioned for production growth given its streamlined cost structure, upcoming drilling programs in the Fayetteville and Marcellus shales, and a wide acreage in its New Ventures, especially in the Brown Dense play. During the second quarter, Southwestern's Marcellus shale operations in the northeastern U.S. produced 9.9 Bcf compared with 5.1 Bcf in the prior-year quarter.

However, we remain apprehensive regarding the weak natural gas scenario in the U.S. arising out of continued oversupply and low demand. This will likely hurt the company's as well as other natural gas companies like Chesapeake Energy Corporation's (CHK) performance in the near term. Moreover, the company's all-in cash operating costs were $1.38 per Mcfe during the reported quarter of 2012 versus $1.28 per Mcfe during second quarter 2011.

Other risk factors include weaker-than-expected commodity prices, technological failures and the lack of a diversified asset base.

The company holds a Zacks #3 Rank (short-term Hold rating). We also maintain our long-term Neutral recommendation on the stock.
 

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