CTRA - Coterra Energy: Accumulate For Oil's Rebound

2024-01-19 11:00:02 ET

Summary

• Coterra raised its 2023 full year guidance in its Q3 results.
• The company is seeing better well results than its peers indicating a team that is operating more efficiently than peers.
• Oil prices are forming a base and will potentially increase in the coming years which creates potential for Coterra to issue a special dividend in the next few years.

Coterra Energy ( CTRA ) is a small-cap oil and gas company that focuses on its properties in the Permian Basin and currently has a market cap of $18.6 billion.

I last wrote an article about Coterra Energy on September 24, 2023, giving Coterra a Strong Buy rating. At the time, Coterra Energy was trading for $26.01 per share and today, it is trading for about $24.82 per share. This equates to a decline of 4.8%. During that same time frame, oil has declined from $89.50 to $72.50 which equates to a decline of 19%. Natural gas prices during that same time period have gone from $2.63 to $3.25 as we are currently in the midst of a polar vortex in Canada and the United States.

Since my last article, Coterra reported earnings for the third quarter on 11/6/2023. Thanks to strong results, Coterra was able to raise their full-year guidance, which they are expected to report sometime in February.

Balance Sheet

In my last article, I compared Coterra's balance sheet debt-to-asset ratio relative to other companies to demonstrate that Coterra has a very good balance sheet. Any time an oil company's balance sheet is on par with EOG Resources, then you know they are managing their balance sheet well.

Source: Seeking Alpha

The company's long-term total of $1.592 billion in debt consists of:

• 3.65% senior notes private placement: $825 million
• 3.90% senior notes due May 15, 2027: $750 million
• 4.375% senior notes due March 15, 2029: $500 million
• Less: portion of long-term debt that is current $575 million

Cash Flow

As oil prices have decreased over the past year, the company has seen a decline in its operating cash flow. Regardless, the company has been able to see a nice increase in its capital spending in 2023 which should set it up nicely for when oil prices rebound in the coming years.

The company continues to make it its goal to return 50% of its free cash flow to shareholders through its dividend and share repurchases.

Source: Seeking Alpha

The company's base dividend is 20 cents per quarter which it maintained in Q3. It has historically issued a special dividend as oil prices rise but has not issued a special dividend since Q1 2023 when they issued a dividend of 37 cents in addition to the 20 cent base dividend.

Production

Coterra has seen strong production growth in the year 2023. The company grew its oil production roughly 8%.

In my last article I highlighted these same metrics for EOG Resources and Coterra, given they are a smaller company, they were able to grow overall production slightly faster than EOG Resources on a percentage basis. Although Coterra has acreage in the Marcellus Shale where they could easily ramp up their natural gas production, they are more focused on growing their oil production at the moment. Coterra grew oil production by 5 percentage points faster than EOG Resources which again, highlights the fact that smaller companies that operate well can grow faster than larger companies.

Source: Coterra Q3 Results

The slide below demonstrates how Coterra's production expectations have shifted since they reported their Q3 results. Given they are approaching the end of the year, they were able to narrow their full year expectations into a smaller window (blue bar in slide below), but each window is either above previous expectations, or on the higher end. This was achieved while keeping their capital expenditure at the low end of their expectations indicating better rates of return than originally expected.

The Permian

For FY2023, the company expects to have completed 85-95 net wells. This slide provides an overview of where their acreage is located throughout the Permian, as well as a look at what they have accomplished in 2023.

In the Delaware Basin, according to Enverus Prism's data, Coterra's 2020 and 2022 results sat at or near the top of the results per lateral foot drilled. As the company warns in the slide below, this was partly due to their Lea County wells in those years. Going forward, their wells will be 2/3 Texas and 1/3 New Mexico (Lea County) and so you might not expect results this robust in the future, but they should still be relatively attractive.

The Marcellus Shale

The Marcellus Shale is primarily heavy in natural gas production. The company has seen results from its Marcellus Shale that sit above its peers. This data was collected from Enverus Prism and according to the footnote, other major operators in the Marcellus include companies like Southwestern Energy ( SWN ), Range Resources ( RRC ), Chesapeake Energy ( CHK ), and EQT ( EQT ) . So either Coterra has acreage in the Marcellus in a better area than their peers, or they are more technically savvy.

Conclusion

Coterra is still a Strong Buy in my estimates. They delivered strong results in their Q3 quarter and should oil prices increase, 2024 could see a nice increase in share price as well as an attractive special dividend in the future. The company has somewhere between 15 to 20 years of drilling inventory and so they have a long runway of strong capital return projects. Of course, they will find ways to add more over that time frame.

Given that Coterra is a smaller company, they are able to have more focused growth, but I also believe the company is valued fairly at current prices relative to its faster growth. Coterra, being focused primarily in the Permian Basin, has been able to grow production while employing a capital return program at the same time indicating good rates of return on their capital expenditures.

Oil Outlook

Currently, the World Economic Forum is holding its annual conference at Davos. Think what you want to about the WEF, interesting news came from the conference related to oil as Occidental Petroleum's ( OXY ) CEO, Vicki Hollub gave a presentation . She pointed out that by 2025, the world's oil supplies will be in a deficit to oil demand. Furthermore she stated,

The ratio of discovered resources versus demand has dropped in recent decades and is now at around 25%

I'm not the kind of investor who reads these headlines and believes that oil prices will immediately skyrocket starting in 2025, but I do believe that oil prices will need to begin to increase to unlock the necessary capital investment to meet the world's oil demand. The market will figure it out, but it will likely require higher oil prices to do so. As I also believed this in 2023, I think its likely time to start positioning for higher oil prices.

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