May 27, 2021
[5 min Read]
Cabot Oil and Gas has recently posted very strong financials in it Q1 earnings release and is trading at multiples lower than its competitors despite having better leverage, liquidity, and profitability ratios. Based on a company comparables valuation specific for oil and gas companies, there is room for up to 50% of appreciation based on the company's current price.
Cabot Oil and Gas Corporation (NYSE: COG) is an oil and gas company that develops, exploits, explores, and produces natural gas in the United States. It exclusively focuses on the Marcellus Shale with 175,000 acres in the dry gas window of the area located in Susquehanna County, Pennsylvania.
As of December 31, 2020, it had proved reserves of approximately 13,672 billion cubic feet of gas, and 15 thousand barrels of oil or other liquid hydrocarbons. As the majority of its revenue comes from natural gas; the company is most susceptible to price swings in this commodity.
Cabot Oil recently released its first-quarter 2021 results. Its adjusted earnings per share were at $0.38 per share, which beat analyst expectations. Its natural gas price realization improved 34% from the prior-year period and rose to $2.31 per Mcf. Moreover, proved reserves increased by 6% in 2020 to 13.7 Tcfe. During the quarter, 28 wells were drilled and 14 were completed.
From a revenue perspective, COG's Q1 revenues were up 18.9% to what they were a year ago, near the revenue levels experienced in 2019 before the trough in gas prices created due to COVID.
Discretionary cash flow improved to $261.2 million, well above the $198.5 million in the prior-year period. The increased cash flow led to a 10% dividend increase to $0.11 per share. This falls in line with the company's strategy to achieve a minimum capital return target of at least 50% of annual free cash flow.
From a solvency perspective, the company's Debt/LTM EBITDA ratio is sitting at 1.3x, and with no debt outstanding under its credit facility, it has $1.6 billion of liquidity.
Overall, EPS improved this quarter as did margins, with revenues greatly increasing and expenses slightly decreasing. This can be attributed to the volatile swing in the price of oil and gas throughout 2020 and the fact that at one point the WTI was trading at a negative due to the price cuts and an already saturated market. Despite this, COG was still able to repay all its debt and retain solvency and liquidity, indicative of great management and financial planning.
From a financial standpoint, the company is strong, and as its reserves grow and commodity prices rebound, it is poised to continue to deliver returns to shareholders.
The downturn in the oil and gas industry caused by COVID-19 was like any other.
The majority of the downside risk for oil and gas companies comes from commodity prices, driven by supply and demand. If natural gas prices remain low, margins can steadily decrease. Global oil demand fell by 25% in April but has strongly rebounded since then. Oil demand has been expected to recover strongly this year but remains lower than pre-COVID levels.
In addition, the COVID-19 crisis has accelerated the long-term trend of entry transition to more renewable resources. However, given that natural gas is one of the cleanest fossil fuels available at the lowest price, the projected share of gas in the future energy mix is projected to increase. The US Energy information administration estimated gas prices to average $3.14/MMBtu in 2021. YTD prices have averaged around $2.9/MMBtu and are poised to rise throughout the year.
In addition, analysts project an increased trend of consolidation in the shale market to create more balance and diversification for US oil and gas companies.
Cabot is trading at a discount of almost 50%. This is supported by its strong financials relative to its peers and low trading multiples.
The primary rationale behind buying COG at its current price of $16.65 is because of the inability of the market to recognize the advantage it holds over its competitors coming out of the COVID-19 oil and dip in natural gas prices. From an EV/Production point of view, it is trading at a large discount to its competitors, which are trading at multiples upwards of 10x while it is still at 8.7x. This is unreasonable given that it has an EBITDA margin higher than the median 38% of its competitors, has a Debt/EBITDA sitting at 1.3x lower than all its competitors, and has the highest return on capital of 7.10% out of all its competitors.
Based on the prices the market has placed on its competitors, COG is clearly trading at a discount right now and there is great room for appreciation once the market corrects itself. It is incorrect to say that the cyclicality of the industry is what has resulted in this discount as its competitors have been equally impacted by the crisis, but from a financial point of view COG still has the best balance sheet and capacity to provide returns in excess of its cost of capital in the future.
Using the Median EV/Production Multiple from the comparable companies analysis, COG should be currently trading at $24.77, which represents a significant 48.7% premium to its current price. If this premium is sensitized for both the current price and EV/Production multiple, it still stays above a minimum of 23%, representing a great investment opportunity.
Merger with Cimarex.
This valuation and analysis for COG were based on Cabot as a standalone company. However, it is common knowledge that recently the company announced that they'd merge with Cimarex Energy in an all-stock deal. This announcement led to a drop in share price by 6%.
Cimarex Energy focuses on oil while Cabot focuses on natural gas. This merger brings together two firms operating in different regions that extract different commodities and create a more diversified firm overall. Having a mix of assets in oil, gas, and natural gas liquids will protect the company against price swings in any single commodity, in turn providing more diversification for shareholders.
The deal is expected to provide cost savings of about $100 million from general and administrative segments. Beyond that, both companies should operate normally, so it is likely the market negatively overreacted to this news.