Introduction

In last week’s Energy Letter, I discussed the world’s top publicly traded natural gas companies. That list is very dependent on the how one defines a natural gas company. For instance, ExxonMobil (NYSE: XOM) is the top global natural gas producer with a recent production rate of 10.1 billion cubic feet (bcf) per day. However, because Exxon is an integrated supermajor, it derives a smaller fraction of its earnings from natural gas than the gas-focused drillers.

In fact, the six publicly traded supermajors — ExxonMobil, Royal Dutch Shell (NYSE: RDS-A), Total (NYSE: TOT), BP (NYSE: BP), Chevron (NYSE: CVX) and Eni (NYSE:E) — also happen to produce more natural gas than anyone else. They just don’t depend on that commodity as heavily as they do on oil production, and in some cases on fuel refining.

If we look only at the exploration and production (E&P) companies without refining operations, then ConocoPhillips (NYSE: COP) is the world’s top natural gas producer with recent daily production of 4.1 bcf/day. However, more than 60% of Conoco’s gas production takes place overseas and the company obtains more revenue from oil than from natural gas. Thus, COP is more of an oil company than a gas company, and an international one at that.

Looking only at U.S. gas output, Chesapeake Energy (NYSE: CHK) is the largest producer among the E&P companies at 2.9 bcf/day in the second quarter of 2015. But, as with ConocoPhillips, Chesapeake now derives more income from oil than from natural gas. In 2014, Chesapeake reported $3.5 billion in oil revenue, $2.6 billion in gas revenue, and $700 million in natural gas liquids (NGL) revenue. So by that measure, Chesapeake is now more oil company than gas company.  

Focusing on the E&P companies that obtain more revenue from natural gas sales than from oil sales produced the following top 10, sorted in descending order by gas revenue:

• EV = Enterprise Value in billions as of Sept. 21
• EBITDA = Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in billions
• Debt/EBITDA = Net debt at the end of Q2 divided by TTM EBITDA
• FCF = Levered free cash flow for the TTM, in billions
• Res = Total proved oil and gas reserves in billion barrels of oil equivalent (BOE) at year-end 2014
• Gas Rev = Revenue from natural gas for fiscal 2014, in billions
• Gas Res = Year-end 2014 natural gas reserves, in trillion cubic feet
• CR = Current Ratio (current assets divided by current liabilities)

(Note that Cabot’s EBITDA and related metrics show the effect of a $771 million non-cash impairment charge taken in December to account for the diminished value of non-core oil fields in east Texas. Adding back that sum would yield metrics much more in line with the competition.)

This table lists the E&Ps that are the largest publicly traded companies dependent primarily on natural gas output. All of these companies are based in North America. There are two Canadian companies on the list — Encana and Conservative Portfolio holding Peyto Exploration and Development. Besides CONSOL, which mines coal in addition to drilling for natural gas, the rest are oil and gas companies — with the emphasis on gas.

Below are brief overviews of each company.

Encana (NYSE, TSX: ECA) is headquartered in Calgary, Canada. The company is an oil and gas producer with interests in British Columbia, Alberta, offshore Nova Scotia, Texas, Colorado, New Mexico, Louisiana, and Mississippi. Encana is the second-largest company on this list with an enterprise value of $12.2 billion. At the end of 2014 the company had proved oil reserves of 205 million barrels, of which 59% were classified as developed. The company’s gas reserves totaled 5.5 bcf, down sharply from the 12.8 bcf at the end of 2011. Encana has shifted back and forth between oil and gas production depending on its expectations for the commodities, but it has been plagued by lousy timing, getting rid of both oil and gas assets near market bottoms and acquiring interests at much higher valuations.

In the most recent quarter, Encana reported that its transformation back to a predominantly oil company is well underway. It reported an 87% year-over-year increase in liquids production, and devoted more than 80% of capital spending to the four basins it currently favors; the Permian, Eagle Ford, Duvernay and Montney. Second quarter cash flow totaled $181 million despite an operating loss of $167 million and a net loss of $1.6 billion (primarily due to a $1.3 billion non-cash, after-tax impairment.) Encana’s EV/EBITDA ratio of 3.9 is the second-lowest among the stocks on this list. Shares come with a dividend currently yielding 3.8%.

Houston-based Southwestern Energy (NYSE: SWN) has the second-highest natural gas revenue on our list, but it ranks 5th based on enterprise value. This is primarily because Southwestern is nearly a pure play on natural gas, which makes up 91% of its proved reserves. The company’s primary focus is on the Fayetteville Shale in Arkansas and the Marcellus Shale in northeast Pennsylvania. By volume of gas produced, Southwestern is the fourth-largest natural gas producer in the U.S. behind ExxonMobil, Chesapeake, and Anadarko Petroleum (NYSE: APC).

Southwestern has a current ratio below 1, so liabilities currently exceed assets. It also has relatively high negative free cash flow (FCF). On the plus side, its EV/Reserves ratio is one of the lowest in the group. Southwestern’s Standardized Measure stood at $7.5 billion at the end of 2014, giving it an EV/SM of 1.3. In other words, the company’s market capitalization and debt add up to 30% more than the value of proved reserves currently on the books. In the most recent quarter, Southwestern reported record production of 245 billion cubic feet of gas equivalent (Bcfe), but a net loss of $815 million.  

Growth Portfolio recommendation EQT (NYSE: EQT) is the largest company on this list and is presently our #3 Best Buy. EQT is one of Appalachia’s largest exploration and production companies, developing unconventional reservoirs such as shale, tight sands, and coalbed methane. At the end of 2014 the company had 10.7 trillion cubic feet of proved natural gas, NGLs, and crude oil reserves across approximately 3.4 million gross acres, including approximately 630,000 gross acres in the Marcellus.

In the second quarter EQT launched an initial public offering for EQT GP Holdings (NYSE: EQGP), representing its general partner interest in an affiliated midstream MLP. EQT retained 90% of EQGP, which itself owns a 30% LP interest, 2% GP interest and the related incentive distribution rights in EQT Midstream Partners (NYSE: EQM). EQM provides natural gas gathering, transmission, and storage services in the Appalachian Basin. It owns and operates approximately 8,200 miles of gathering lines and 176 compressor units.

EQT reported adjusted operating cash flow of $157.3 million in the second quarter, $125.6 million lower than in the same period last year. Production sales volume was 34% higher than a year ago and midstream gathering revenue was 35% higher, but the realized natural gas price was 40% lower.

Growth Portfolio recommendation Cabot Oil & Gas (NYSE: COG) is another Marcellus producer (in fact the largest on the list), and is the lowest cost producer listed. No other company comes close to COG’s lifting cost of $0.22 per thousand cubic feet of gas equivalent (Mcfe), based on the data from S&P Capital IQ. To put this in perspective, the second and third lowest-cost producers on the list are EQT at $0.28/Mcfe and Peyto at $0.29/Mcfe.

The growth in Cabot’s proved reserves and production has been staggering. In 2010 the company had proved reserves of 2.7 trillion cubic feet of gas equivalent (Tcfe) and produced 131 Bcfe of gas. By 2014 those numbers had grown to 7.4 Tcfe of gas reserves and 532 Bcfe of production. One of Cabot’s disadvantages is that its production doesn’t have sufficient access to the lucrative markets on the East Coast, but that access will improve in mid-2016 when the Constitution Pipeline project is due to be completed. This pipeline will transport Cabot’s natural gas into New York State, helping the company realize higher natural gas prices.

In Q2 2015, Cabot reported production of 128.4 Bcf of natural gas and 1.6 million barrels of liquids production. Gas production was 5% higher than in the same period a year ago, while liquids production rose by 68% as Cabot ramped up output in the Eagle Ford shale. Cash flow from operations was $171.2 million, compared with $329.6 million in the second quarter of 2014.

Antero Resources (NYSE: AR) is yet another natural gas producer operating exclusively in the Appalachian Basin in West Virginia, Ohio and Pennsylvania. The company owns and operates 153 miles of gas gathering pipelines in the Marcellus shale and 96 miles of pipelines in the Utica shale. Antero was formed in 2002 but didn’t go public until October 2013. Oil and gas prices began a dramatic decline less than a year later.

Antero’s 40%+ production growth guidance for 2015 is tops among U.S. large-cap E&Ps. This robust growth was a factor in Antero’s IPO of Antero Midstream Partners (NYSE: AM), which debuted in November. Antero Midstream’s pipelines move Antero Resources’ production to market.

Growth Portfolio recommendation Antero may be the most underrated stock on this list. It has the largest proved reserves, is projected to have the fastest growth this year among the large oil and gas E&Ps, has a low level of debt and yet trades at one of the lowest multiples for this screen.

The company recently announced plans to sell its integrated water business to Antero Midstream for $1.05 billion, further strengthening its balance sheet. Antero Resources is also well-hedged. Of the 1.4 Bcf/d of production guidance for 2015, the company has 1.316 Bcf/d hedged at $4.43/MMBtu. In 2016, 92% of production guidance is hedged at $4.02/MMBtu.

Texas-based Range Resources (NYSE: RRC) produces natural gas and oil in the Appalachian and Midcontinent regions. The company owns 7,582 net producing wells and approximately 1.4 million net acres under lease in the Appalachian region, and 653 net producing wells and approximately 383,000 net acres under lease in the Midcontinent region, primarily in Texas and Oklahoma.

In the second quarter of 2015, production volume reached a record high of 1.373 Bcfe/d, a 24% increase year-over-year. But revenue dropped to $248 million, down 68% year-over-year. Range Resources posted a quarterly net loss of $119 million, versus earnings of $171 million a year ago.

Tulsa-based WPX Energy (NYSE: WPX) is a Growth Portfolio recommendation that was spun off from Williams (NYSE: WMB) in 2011. The company focuses on natural gas and natural gas liquids in the Piceance Basin of the Rocky Mountain region, and on crude in the Williston Basin in North Dakota and the San Juan Basin in the southwestern United States. WPX is the smallest company on this list, and also trades at the lowest EV/EBITDA and EV/Reserves ratios.

WPX is reshaping its historically gas-weighted portfolio toward higher oil production. Q2 results reflect this transition, with crude output up 38% year-over-year to 32,700 bpd. Natural gas production declined 15% from a year earlier.

WPX recently agreed to acquire privately held RKI Exploration & Production, LLC for $2.35 billion plus the assumption of $400 million of debt. Most of RKI’s leasehold is located in the Permian’s Delaware Basin. The acquisition will add approximately 22,000 boe/d  – more than half of it oil – to current production and includes more than 375 miles of scalable gas gathering and water infrastructure

Ultra Petroleum  (NYSE: UPL) operates in the Appalachian Basin, but also has natural gas reserves in the Green River Basin of Wyoming and oil reserves in the Uinta Basin of Utah. All you really need to know about Ultra is that it has a very weak balance sheet, and that its financial position has deteriorated year after year. Interest payments have more than tripled from $49 million in 2010 to $157 million in 2014 while revenue has remained relatively flat.  

CONSOL Energy (NYSE: CNX) is the oddity of the group. CONSOL engages in conventional and shale gas exploration as well as coal bed methane extraction. But the company is primarily a coal producer, with coal revenue doubling natural gas proceeds last year. Given the outlook for the coal sector, this is one I would avoid.

Canadian producer Peyto Exploration & Development (TSX: PEY, OTC: PEYUF) was covered in depth in the last Energy Strategist. Notably, Peyto’s 27.9% profit margin places it  near the top of the list, and it is the highest yielding stock discussed here with a current annualized yield of 4.5%. Peyto has a long track record of outstanding performance, but the result is that the company is richly valued based on the EV/EBITDA and EV/Reserves ratios.

Of the companies listed, portfolio picks Antero Resources and WPX Energy seem to be the most undervalued, while Ultra Petroleum and CONSOL Energy are the riskiest bets. Portfolio recommendation EQT seems to be fairly valued, as does Cabot Oil and Gas once the $771 million non-cash impairment charge taken in December is excluded. But Cabot should also benefit from the Constitution Pipeline, which should start shipping gas in mid-2016.

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