Energy shares have been among the poorest performers in the market this year, up +4%, year-to-date, through November, vs. the S&P 500's more than 15% return. Additionally, until recently, natural gas stocks have lagged.
In 2012, the price of natural gas dropped to a decade low level below $2 per Mcfe. The erosion was attributable to a combination of increasing supply, reflecting the success of new drilling technology, as well as weather and economy-related below normal demand.
We believe that supply-and-demand forces are coming back into balance. Demand has been helped by users migrating to cheaper gas from other fuels such as coal. Supply has been cut by repositioning drilling rigs to oil. As a result, natural gas prices have nearly doubled off the bottom to today's price of $3.60; however, for many projects and companies, it is still by and large uneconomical to drill for gas in the U.S.
But thanks to its superior engineering expertise and drilling capabilities SWN is an exception, as it has one of the industry's lowest finding and producing costs,. In 2011 the company grew its production and reserves by almost 20%, at an F&D cost of only $1.31 per Mcfe.
As the sixth largest independent natural gas producer in the U.S., with a 99% focus on gas, SWN is poised to benefit from the expected recovery in natural gas pricing.
Historically the company's drilling operations have been concentrated in two areas, Fayetteville, Ark. (65% of capital spending and 87% of last year's production) and the Marcellus Shale formation in Pennsylvania (25% of capital spending and 5% of 2011 production, but increasing rapidly).
More recently, SWN has been drilling in eastern Colorado, New Brunswick, Canada and the Lower Smackover Brown Dense Play (LSBD), a liquid gas play, in southern Arkansas and northern Louisiana. One industry analyst believes the LSBD play has the potential to be a game changer for the company with a possible value exceeding the current share price. The company has methodically increased its drilling in the play but has provided limited information about its commercial prospects. More information is expected in a few weeks when SWN releases its 2013 capital budget.
What we like about SWN:
- The management team has a track record of growing production at an industry leading low cost. From 2006-2011 the company averaged over 40% annual production and reserve growth and annually replaced over 400% of production at an F&D cost of $1.31 per Mcfe.
- The company boasts a strong balance sheet (its year-end 2011 net debt-to-book capitalization was 30%). The balance sheet combined with cash flow allows the company to invest in its business and develop its oil and gas producing acreage.
- The current share price trades at a significant discount to analyst's estimates of asset value (around $50 per share) without giving any value to new venture plays such as LSBD.
- It has timely prospects as natural gas is currently a cost-effective, clean energy solution for the U.S.
Overall, we like SWN as a year-end stocking stuffer and we are expecting good things from the company in the upcoming year.