SWN - Comstock's Growth Is In Purgatory Until The End Of 2024

2023-12-26 10:20:27 ET

Summary

• Comstock faces revenue decline due to challenging natural gas market and may be exposed to price swings due to reduced hedging.
• Management remains optimistic about future prospects with new LNG export capacity and potential for M&A.
• Comstock plans to increase gas production, add rigs, and expand G&P capacity to meet growing demand and fill export capacity.

Comstock ( CRK ) experienced a continued decline in revenue generation as the firm faces a challenging natural gas market. With 18% of gas production hedged for Q3’23, the firm held significantly more exposure to price swings when compared to its historical rate and other gas producing peers, resulting in a 28% decline in revenue on a TTM basis. Despite these near-term headwinds, management remains optimistic about the future of their strategic Haynesville/Bossier assets relating to new LNG export capacity coming online at the end of 2024 and going forward and has even suggested that some consolidation through M&A is on the table. Given the challenging natural gas market, the firm’s minimal hedging exposure, the new LNG export capacity, and the possibility for M&A, I provide CRK shares a HOLD recommendation with a price target of $7.89/share.

Operations

Comstock increased gas production by 3% sequentially to 1.4Bcfe/d in Q3’23 with an average realized price of $2.33/Mcf, a $0.22/Mcf differential to the reference price of $2.58/Mcf. Their hedged gas realized a price of $2.41/Mcf. The firm is 18% hedged throughout the duration of 2023 and has hedged 22% of gas for 2024. Management did mention that they’d like to increase their hedges to 40%+ to mitigate some of the pricing risk related to the low strip price.

Looking ahead, management remains very optimistic about the long-term trajectory of the domestic gas market with new LNG export capacity coming online towards the end of 2024 and beyond. Management discerned in their Q3’23 call that overall gas production will need to increase by 4.5-5Bcf/d by the latter half of 2024 and by an additional 1Bcf/d every year going forward just to fill export capacity. The EIA reported that 9.7Bcf/d of export capacity will be added in the US alone through 2027.

As a result of the increased demand, Comstock will be adding an additional rig in the Western Haynesville in 2024 and one more in 2025 for a total of four rigs. In total, Comstock will be running five rigs in the legacy Haynesville assets and three rigs in Western Haynesville in 2024. Based on management’s comments, the firm will relocate one rig from the core assets to Western Haynesville to maintain the same number of rigs. Management discerned Q4’23 gas production will be in the range of 1,450-1,550MMcf/d.

Comstock provided some color to future operations in their latest earnings call with the expectation of filling their G&P capacity at their Bethel plant of 500MMcf/d by 2025. The firm is also partnering with QL, an affiliate to Quantum Capital, to invest $300mm to build out capacity by 4x at their Pinnacle G&P facility, from 500MMcf/d to 2Bcf/d by 2028. Comstock will allocate 80% of distributions to Quantum until the investment hurdle is achieved, in which the distribution rate will be reduced to 30%. This will be covered by transportation and processing fees in the form of $0.54/Mcf.

Management expects to produce anywhere between 1,450-1,550MMcf/d in Q4’23. Natural gas prices throughout the quarter have been relatively volatile, peaking at around $3.80/Mcf at the end of October down to $2.31/Mcf in December. I’m expecting anywhere between $458-$484mm for Q4’23 with FY23 revenue of $1,613-$1,639mm. I’m expecting EBITDA margins to continue to trend downwards towards 52%, generating between $836-$850mm for the year as the firm may face continued low gas prices through the end of the year.

I think if you ask me if I'm going to do a big M&A and double the size of my company, then I'd do a big M&A. And I don't know what the M&A would be. If I'm out here derisking the Western Haynesville and you know we're going to add a third rig next year, we have to see how these wells hold up.

Miles Allison

Valuation

CRK trades at the higher end of their cohort of natural gas producers in the Haynesville Basin.

Looking forward to eFY23, the stock may experience some downside risk as the firm awaits LNG export capacity to come online towards the end of 2024. Though the average valuation multiples across their peers suggests a SELL rating, I do believe the firm is well positioned to weather the near-term headwinds and experience a significant upswing as the Golden Pass and Plaquemines commence operations. There is also the possibility of M&A activity on the horizon as industry consolidation progresses. As I discerned in my recent update article covering Southwestern Energy ( SWN ), I believe Comstock’s Haynesville assets can potentially be a complementary addition to Southwestern’s. Though neither firm has directly discussed specific names when discussing M&A, each firm has suggested independently the opportunity for M&A.

Given the near-term profitability risks with the possibility of M&A activity, I provide CRK a HOLD recommendation with a price target of $7.89/share through 1h24. This provides the firm with a value of 3.75x TTM EV/EBITDA, which I believe to be a reasonable takeover price for their quality assets. Assuming no consolidation were to take place, I believe the end of Q2’24 would be the time to start building a position in CRK in preparation for the upswing as LNG export capacity comes online.

For further details see: