CTRA - Coterra: Navigating Energy Transition With Resilient Balance Sheet

2023-11-01 12:25:30 ET

Summary

• Coterra Energy Inc.'s robust balance sheet and efficient cost management bolster the company's resilience.
• Diversified revenue streams offer stability despite industry challenges.
• Priced at 13x forward free cash flows, Coterra presents an attractive investment opportunity for upside potential.

Investment Thesis

Coterra Energy Inc. ( CTRA ) is about to report its Q3 results post-market next Tuesday, November 7th. According to my estimates, Coterra is priced around 13x forward free cash flows.

What's more, as you'll see, there's a lot to like about Coterra. Not only is the business highly free cash flow generative, but also, it has perhaps one of the best balance sheets in the sector.

This allows Coterra to continue returning capital to shareholders, even as many of its peers have had to stave away the free cash flows to improve their balance sheets.

Also, I explain why natural gas is key to the energy transition. In sum, there's a lot to like about Coterra, even if there are some blemishes in the investment thesis.

Why Invest in Natural Gas?

The ongoing energy transition marks a definitive shift from traditional oil-based energy sources towards the adoption of natural gas and nuclear energy. I've already discussed nuclear energy here so I won't focus on that aspect further in this analysis.

This strategic redirection is underscored by a growing momentum towards the electrification of numerous sectors, including the widespread integration of EVs and heat pumps.

This comprehensive electrification initiative is poised to significantly reduce reliance on fossil fuels, thereby promoting environmental sustainability and curbing carbon emissions.

Concurrently, the burgeoning significance of AI, cloud, and data centers and the ongoing digital transformation underscores their deep energy consumption requirements.

With this confluence of factors, the demand for electricity is expected to escalate rapidly over the next 2-3 years, signifying a pivotal phase in the global energy landscape's transformative journey. I believe this energy transition is best illustrated in the graphic that follows.

Since the summer, natural gas prices have moved higher by more than 60%, while oil prices have increased less than 25%.

And this is not about seasonals, since natural gas is now in shouldering season, the transitional periods between seasons, primarily spring and fall, when the demand for natural gas is relatively lower compared to the peak seasons of winter and summer. During these shoulder seasons, the weather is milder, and the need for heating or cooling is reduced, resulting in a decreased demand for natural gas. This period often witnesses a decline in natural gas prices due to the decreased demand.

Why Invest in Coterra?

Coterra is about to report its Q3 2023 results next week, Tuesday.

Despite rapidly rising natural gas pricing, Coterra has evidently been the peer group's laggard in the past 6 months.

One prominent issue that has held Coterra back boils down to its portfolio's diversification (more on this soon). That being said, even as many peers in the Marcellus region worked to bring down their cost structure in Q3 to around $2.25/mmbtu Henry Hub, Coterra has already been at that cost for some time.

Indeed, we'll have to hear from Coterra's management whether they've had even more success in the current high inflation environment in bringing down their cost structure further.

Next, there are other elements to like about Coterra too. For example, what makes Coterra superior to many of its peers is that its balance sheet is very strong, see below.

As you can see here its net leverage is remarkably low. This has allowed Coterra to continue returning capital to shareholders. Presently, Coterra's framework is to return 50% of its free cash flow as buybacks and dividends.

What's more, as you can see from the graphic above, even at lower WTI and natural gas prices, Coterra is free cash flow positive.

Accordingly, at the present WTI and natural gas prices, I believe that Coterra could end up reporting around more than $1 billion of free cash flow over the next twelve months, at least. But likely to be closer to $1.5 billion in free cash flow. This leaves Coterra priced around 13x forward free cash flow. That's not the cheapest oil and gas play, but very much in the middle of the pack.

What's the Downside to Coterra?

This is down to investors' overall preference, but Coterra is diversified beyond just natural gas production. Even though the bulk of its revenues stem from natural gas exposure, it also holds significant exposure to oil prices and natural gas liquids.

This implies that although the stock is attractively priced, as the energy transition continues to take shape and demand for natural gas as a destination fuel continues to gather moment, and displacing oil as the primary energy source around the globe, this diversification could stop Coterra from fully participating in the energy transition.

The Bottom Line

In sum, despite certain challenges and diversification concerns, Coterra stands resilient with its robust balance sheet and efficient cost management.

With its strategic positioning in the natural gas and energy sector, Coterra has demonstrated a consistent ability to generate significant free cash flows, underpinning its potential for further capital returns to shareholders.

As the energy transition gains momentum and natural gas remains a pivotal part of the evolving energy landscape, Coterra's resilience and adaptability position it favorably for future growth and sustained profitability.

With its current valuation reflecting a promising investment opportunity, Coterra is well positioned to capitalize on the evolving dynamics of the energy market.

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