Last year was a telling year on a few things (in our mind) about the mindset of a shale executive. Natural gas prices averaged $2.53/MMBtu last year with prices tanking below $2.5 by the summertime. How producers reacted to such a dire price situation tells us a lot about the capital allocation of the management team.
In all of the US shale E&P names, the blue-chip standard is Cabot Oil & Gas (COG). The company generated free cash flow of $563 million and bought back shares. The company also discloses return on capital employed, a metric very few E&Ps disclose at all. In addition, it was able to grow production slightly while keeping FCF positive.
But the downside to COG is that it’s not cheap. It’s currently trading at 5.40x EV/FFO and FCF multiple of 11.69x.
Source: Company 10-K
So outside of COG, we only see EQT (NYSE:EQT) as the other viable producer at $2.53/MMBtu gas. It generated FCF of $249 million with a small increase in overall production. Net debt also is manageable here, while the valuation discount is ~21% to COG.
While it’s not as cash flow generative as COG, EQT is the largest natural gas producer in the US by far now thanks to the acquisition of Rice Energy. Our take is that EQT in comparison with the likes of Range Resources (NYSE:RRC), Antero (NYSE:AR), Southwestern Energy (NYSE:SWN) and Gulfport Energy (NASDAQ:GPOR) gives investors a durable enough outlook to weather the current commodity environment.
If natural gas prices start to improve toward the end of the year from falling production and higher demand, we expect EQT to plow back all of the excess FCF to share repurchases and debt pay-down.
As for Antero, the actions of 2019 demonstrate just how misaligned the management team is. In order to push production up, the management team sold stakes in Antero Midstream. Instead of just guiding lower capex, AR chose to outspend cash flow, which is usually a signal that the management team is not a good capital allocator at all.
Another one, for example, is Range Resources. The company was so free cash flow negative that it sold a royalty interest for ~$700 million and plowed $67 million back into capex. It could’ve just reduced capex and lower overall production to keep paying down debt, but the management team did the exact opposite.
Southwestern Energy is going to struggle big time if natural gas prices remain at $2.50/MMBtu. In 2019, the company reduced production, cut capex, but was still not able to generate FCF at $2.5/MMBtu gas. This means that SWN will have to keep cutting capex, and it still might not be able to pay down the entirety of the 2.242 billion in debt. In essence, if gas price equilibrium is anywhere near $2.5, it’s a zero.
Lastly, Gulfport Energy is an extremely levered play on natural gas. It doesn’t have a debt maturity until 2023, giving it time to weather the storm. But in 2020, the company is cutting capex in half but guiding production to fall from 229k boe/d to 187.5k boe/d or a reduction of…
Read More: EQT Is The Best E&P To Play The U.S. Natural Gas Price Rebound (NYSE:EQT)