CTRA - Coterra Energy: Shifting Outlook From Doubt To Bullish (Rating Upgrade)

2023-06-20 20:02:41 ET

Summary

• Why I'm now bullish on Coterra Energy Inc. due to a changing near-term outlook for natural gas.
• A rise in European natural gas prices indicates potential for increased demand for U.S. exports, benefiting Coterra.
• Coterra's hedging strategy provides a margin of safety and protection against downside risks.
• Potential for significant upside in the natural gas market combined with favorable valuation make Coterra an attractive investment option.

Rapid Recap

How do I know if I'm being inconsistent or being flexible? Recall, about two months ago I believed that I didn't see much value in being bullish on Coterra Energy Inc. ( CTRA ). Consequently, I downgraded the stock from a buy to a hold. Since that time, the share price has remained largely unchanged.

But today, I believe that it makes a lot of sense to be bullish on Coterra. In this analysis, I'll describe the near-term and medium-term outlook for natural gas. And I'll explain why I'm now bullish on CTRA stock.

The Near-Term Outlook Has Changed

In the past few weeks, natural gas stocks have finally woken up. This has been a long time coming.

This is what happened. In Europe, prices are up nearly 50% from the lows set a month ago.

Why such a dramatic move? I believe there are 3 different factors at play.

1. The weather. Warm weather requires more air conditioning.
2. Everyone presumed that there was an overabundance of natural gas and that we wouldn't need natural gas as aggressively as in the past. Here, you can make the argument of energy efficiencies have been found in 2022-2023, where the most energy-intensive manufacturing processes have been dealt with or outsourced.
3. Also, Europe is starting to think about shoring up enough inventory to get past this upcoming winter.

Now, on that final point. Why would prices of natural gas in Europe impact Coterra? Because the higher the prices of natural gas in Europe, the more demand to export natural gas to Europe, which will drag higher the prices of natural gas in the U.S.

After all, there's no reason for prices in Europe for natural gas, a commodity, to be around 5x to 7x more expensive than in the U.S.

Why Consider Coterra?

Here's the thing. As you can read above, I'm extremely bullish on natural gas. The stock that I'm personally invested in is Antero Resources Corporation ( AR ). Although note, Antero Resources may not be for every investor.

For many investors, Coterra makes more sense. What makes me say so? Because Coterra hedges out its natural gas production somewhere approximately 30%.

And this plays out on both sides of the equation.

If I'm wrong to be as bullish as I am on natural gas, then, Coterra's 30% hedged will provide it with a fair margin of safety. In fact, Coterra's hedges have a floor at prices ranging from $3.00 to $7.50 per MMBtu.

Given that natural gas prices are right now around $2.70, this seems quite a positive setup.

The problem though, is that if one is as bullish on natural gas as I am, Coterra's ceiling prices ranging from $4.55 to $13.08 per MMBtu will mean that a significant portion of Coterra's natural gas prices could be capped.

To be clear, between where natural gas prices are now and the high end of Coterra's ceiling is a natural gas price that is unlikely to be reached .

So, that's why I'm interested in Coterra. Because I believe that the business is nicely exposed to the majority of the upside potential that I believe the natural gas market will bring in the coming year. But it also provides some bottom-side protection.

Moving on, if we assume that in 2024 Coterra's capex will be around $2.4 billion, approximately 15% higher than the 2023 midpoint, then Coterra could probably generate around $2.4 to $3 billion of free cash flow.

This puts the stock priced at approximately 7x forward free cash flow.

Furthermore, given that Coterra today is priced at about 12x forward free cash flow if my assumptions come to pass, this would mean that looking out to 2024, Coterra's multiple to free cash flow could actually be significantly cheaper than it seems.

The Bottom Line

Previously, I downgraded Coterra Energy Inc. stock due to a lack of perceived value, but the current near-term outlook for natural gas has prompted a change in my stance.

The rise in natural gas prices in Europe, influenced by factors such as weather conditions and inventory considerations, could lead to increased demand for natural gas exports from the U.S., benefiting Coterra.

The company's hedging strategy provides a margin of safety, protecting against potential downside risks while still allowing for significant upside potential in the natural gas market.

Additionally, if Coterra's capex in 2024 remains in line with projections, the stock's forward free cash flow multiple suggests it could be undervalued.

Overall, Coterra Energy Inc. stock appears to be well-positioned to capitalize on the anticipated growth in the natural gas market while offering some level of protection.

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