2023-11-05 22:55:59 ET
Summary
- Antero Resources exhibits strong growth potential in the natural gas market, with impressive operational performance, deep reserves, and efficient production, positioning it for significant gains.
- AR's strategic advantages, including exposure to growing LNG demand and Tier 1 pricing points, combined with bullish expectations for natural gas prices, offer promising prospects.
- The company maintains a healthy balance sheet and aims to distribute significant cash to shareholders through buybacks, with the potential for substantial growth in stock price if prices remain elevated.
Introduction
It's time to talk about Antero Resources ( AR ) , one of my favorite trades at the moment. This year, I started to cover this natural gas giant, as I liked its valuation and the long-term outlook of natural gas prices.
The stock is up 40% since I wrote an article titled Betting Big On Antero Resources: A High Conviction Trade In The Natural Gas Market .
The stock is up 13% since my September 10 article .
That said, 40% is a good start. It's nothing to be too excited about just yet. After all, natural gas prices and natural gas stocks are extremely volatile.
Nonetheless, we're on the right path to more gains, as the bull case keeps unfolding nicely.
Henry Hub natural gas prices have risen to roughly $3.50 per MMBtu again.
This allowed Antero Resources to report stellar earnings, which also underlined its ability to beat peers when it comes to free cash flow generation and capturing growth in markets like liquid natural gas ("LNG"), the liquified version of natural gas, and natural gas liquids ("NGL"), which are higher-margin byproducts so to speak.
In this article, we'll discuss all of this and more, as I'll make the case for much higher gains in the future, using new developments in the natural gas industry and the company's third-quarter earnings.
So, let's get to it!
A Stellar 3Q23 Production Quarter
When it comes to oil and gas, I care for a number of things:
- I want companies with deep reserves to prevent companies from being forced into (often risky) M&A projects to maintain production levels.
- I want companies with healthy balance sheets, as I'm not looking for recovery plays anymore. I did that in 2020 and 2021. Now, I want quality. If companies are still sitting on a poor balance sheet, they are doing something wrong.
- I want companies that are very efficient producers. This allows them to be profitable when commodity prices are subdued and generate high free cash flow when commodity prices are elevated.
- I want companies that use elevated free cash flow and healthy debt levels to distribute most of their free cash flow to shareholders. Usually, I prefer dividends. However, in natural gas, I make exceptions, as I mainly see it as a trade instead of a long-term (multi-decade) investment.
- Also, when it comes to natural gas, I prefer drillers that have additional benefits like access to LNG export opportunities and pricing and products like NGL.
Antero Resources has all of this.
The company recently announced its earnings. The third quarter showed a strong operational performance.
Notably, the completion pumping hours per day increased to over 17 hours, up nearly 50% compared to a year ago.
In June, the company set a record by pumping for over 22 hours a day. This increase in pumping hours contributed to higher completion stages per day.
Year-to-date completion stages per day averaged 11 stages a day, marking a 35% improvement compared to 2022 and nearly 90% compared to 2019 levels.
These operational improvements have led to significantly shorter cycle times, which reflects the average number of days from drilling to sales. Since 2019, cycle times have decreased by 63%, averaging 160 days in the first three quarters of 2023.
As a result, the faster cycle times and improved well performance have resulted in two production guidance increases for 2023.
- In the third quarter, there was a 9% total production growth compared to the previous year, driven by an 18% increase in liquids and a 4% increase in natural gas volumes.
- On an annual basis, production for 2023 is expected to increase by 225 million cubic feet equivalent per day, a 7% increase from the exit rate in 2022.
Even better, these gains in capital efficiency also lead to reduced maintenance capital budget expectations. Antero anticipates materially lower drilling and completion (D&C) capital in 2024 due to operational efficiency improvements.
Deep & Cheap Reserves
Another thing I love about Antero Resources is its deep inventory and low recovery prices.
As we can see below, AR stands out with the most drilling inventory priced under $2.75 per Mcfe at 22 years.
In other words, AR has the most drilling reserves among its U.S. peers and is able to produce at very low costs.
This also means that in an environment of very subdued natural gas prices, Antero can keep producing while others have to cut production. Once peers start cutting production, slower supply tends to stabilize prices. That's great for AR's business.
The chart below is from AR's Canadian peer, Tourmaline Oil ( TOU:CA ). It confirms AR's numbers. However, it also shows that:
- Canadian players have even deeper reserves.
- Range Resources ( RRC ) has more reserves at even lower breakeven prices than Antero.
This does in no way mean that AR is less attractive. It just adds some context.
So Much Growth Potential
In its 3Q23 earnings call, the company noted that it has seen an increase in crude oil prices due to easing macroeconomic concerns and escalating geopolitical issues in the Middle East.
These conflicts have added volatility to global energy prices, particularly crude oil.
While propane inventories are high, recent weeks have shown positive signs for the propane market.
The U.S. set new records for propane exports, with consistently strong export demand, exceeding the 2022 average by 19%.
Propane export demand is expected to continue increasing in 2024, which could potentially strain U.S. Gulf Coast stock capacity.
Antero, which is a propane producer, is well-positioned to capitalize on its capacity from the Marcus Hook terminal in Pennsylvania, avoiding Gulf Coast constraints.
As the chart above suggests, China is a major driver of growth.
According to Antero, China has added 120,000 barrels per day of propane dehydrogenation ("PDH") capacity in 2023, and an additional 340,000 barrels per day is expected to come online by the end of 2024.
U.S. propane exports to China have increased substantially, with a 44% year-over-year growth in shipments compared to a 19% increase from the Middle East. This highlights the importance of U.S. exports in meeting Chinese propane demand.
Meanwhile, and with regard to supply growth, rig counts in the U.S. have decreased by 21% year-to-date, with a notable decline in both oil and gas-directed rigs.
- The Permian Basin has seen a 40% reduction in rig counts year-to-date, and other NGL-producing basins like the Eagle Ford and Scoop Stack have experienced declines of 35% and 45%, respectively.
With that in mind, it gets better.
Antero has terrific pricing benefits.
During its earnings call, the company mentioned that it sells a significant portion of its natural gas out of the basin, with approximately 75% directed to the LNG corridor.
This is seen as a strategic advantage as it provides exposure to growing LNG demand along the Gulf Coast and Tier 1 pricing points.
The company's sales points are strategically positioned for Tier 1 pricing, while some peers are stuck in Tier 3, resulting in lower pricing.
Antero sells 90% of its gas at Tier 1 pricing, compared to an average of 60-70% for its peers.
Furthermore, going forward, the company is bullish on natural gas prices.
With storage levels expected to balance with the five-year average in 2024, the company anticipates support for natural gas prices based on limited supply growth and tailwinds from strong demand, significantly driven by LNG demand.
So, what about the valuation?
Shareholder Distributions & Valuation
The company also has a healthy balance sheet. It has a sub-1.0x net leverage ratio and less than $1.5 billion in net debt after lowering its debt by $2.1 billion since the pandemic.
As the company aims to remain below a 3.0x net leverage ratio, it has significant room to distribute cash to shareholders.
For that, the company uses buybacks. Through 2027, the company aims to generate between $3.2 and $3.5 billion in free cash flow before dividends and buybacks. This translates to a 36% total free cash flow yield.
Valuation-wise, putting a target on AR is tough.
That's mainly because it's so dependent on the price of natural gas.
Current expectations are that AR could generate $4 in EPS in 2025. Applying a 15x multiple would give us a stock price target of $60, which is 100% above the current price.
In 2022, the company generated $5.21 in EPS.
The current consensus price target is $33, which I believe will be adjusted as natural gas prices rise. The same goes for longer-term EPS expectations.
If we get a scenario of prolonged natural gas prices above $4, I think that AR should trade at least $70.
Needless to say, AR is a highly volatile natural gas stock. It is a part of my trading portfolio, not my long-term growth dividend growth portfolio.
If you're not used to elevated volatility, AR is likely not right for you.
Having said that, in the next few weeks, I'll cover more opportunities in this space, especially a great one that comes with significant dividend potential.
For now, the key message is that AR remains on track to double - even from current prices.
Despite economic weakness, it has economic tailwinds and a fantastic business, allowing for strong free cash flow and pricing benefits.
Takeaway
Antero Resources continues to be a standout choice in the natural gas market.
The company boasts impressive strengths that include a robust balance sheet, efficient production capabilities, and access to LNG and NGL markets.
AR's recent third-quarter performance highlights substantial production growth and operational efficiency, setting the stage for more gains.
With deep reserves and low recovery prices, Antero maintains a competitive edge even in volatile market conditions.
Moreover, the company's strategic positioning for Tier 1 pricing and a positive outlook for natural gas prices reinforce its potential for growth.
While AR remains a high-volatility stock, it's well-suited for trading portfolios, offering the opportunity to double in value from current levels.
For further details see:
Antero Resources: Up 40% Since June With Much More Room To Run