Summary
- 3.8% dividend yield, with lowest-in-the-industry cost structure which helps generate >80% EBITDAX margins.
- 1,445 MMcfe/d of production with a 3-year-CAGR of 21%.
- Delevering program removed FY24 debt; debt now due in FY29.
- 70% slump in natural gas prices is temporary; we expect a surge in 2H23.
Investment Thesis
Comstock Resources ( CRK ) is a Haynesville Basin pure-play natural gas producer closely located to the Gulf Coast corridor and near several large LNG (Liquified Natural Gas) terminals. CRK operates 1,600 wells across 372,000 acres with an average lateral length of 9,989 feet.
For all of FY22 CRK generated $673 million in free cash flow from operations. CRK additionally operates the industry’s lowest operating cost structure, which drives its very high 83% EBITDAX margin. CRK intends to retain the current dividend amount of $0.50 per year in the current pricing environment.
Due to its high FCF generation, and low costs, we believe that CRK is a good choice for dividends. We expect the slump in natural gas prices to be temporary, and thus also think CRK would be a good choice for capital appreciation.
Estimated Fair Value
EFV (Estimated Fair Value) = E24 EPS (Earnings Per Share) times P/E (Price/EPS)
EFV = E24 EPS X P/E = $4.25 X 5.0 = $17.60
We have used a low-end P/E within the 4-10x range that oil and gas exploration companies usually fall. With its growth, CRK could easily trade at the high end.
Comstock Resources | E2023 | E2024 | E2025 |
Price-to-Sales | 1.3 | 1.2 | 1.2 |
Price-to-Earnings | 2.3 | 3.3 | 2.7 |
Operations
Production was at 1,445 MMcfe/d (millions of cubic foot equivalent per day) of natural gas in 4Q22, with production growing at a 21% 3-year-CAGR. Year over year, there was a 9% increase in daily production, with a far more favorable pricing environment allowing for better financial results.
FY23 quarterly production is expected to be at least the same as in 4Q22 but could go as high as 1,550MMcfe/d.
CRK is an advantageous geographic location, with direct access to gulf coast markets, selling approximately 71% of natural gas in the local geographic area. This includes 17% of production directly sold to LNG shippers. In 4Q22, the average realized price was $5.57/Mcf at 47% of production hedged. The $5.57/Mcf number is disappointing given the 3Q22 price realization of $7.72/Mcf, but it is still a 6.5% increase yearly. Hedging is lower in FY23, with only 30% of production hedged thus far at $3.00/Mcf.
For FY22, the average lateral length of wells was 9,989 feet. Total D&C costs (drilling and completion) averaged $1,425 per lateral foot drilled over the same period. This translates to just over $1 billion in D&C costs. 4Q22 guidance is expected to be higher than the yearly average of 1,400 MMcf/d, at approximately 1,470 MMcf/d. All in costs are expected to be equivalent to FY22, which were $1.63 per Mcf (thousands of cubic feet). Well-level cash operating costs are $0.82 per Mcf.
We don't expect a block-busting drilling expansion to take place in FY23. However, it is certainly worth noting that the Western Haynesville expansion into Robertson County had an IP (initial production) of 42 MMcf/d. While IP numbers trail off once the well reaches full production, this is still much higher than the average IP of 25 MMcf/d CRK usually sees in the other fields. On the 4Q22 earnings call, management said it was too early to speculate on potential output or costs for the area.
CRK 2022 Drilling Results Map (4Q22 CRK report)
Natural Gas Prices
Freeport LNG terminal being closed after an explosion damaged it over the summer has hurt export volume and US domestic natural gas pricing. The Freeport terminal accounts for around 20% of US LNG Exports. Re-opening was expected to restart in early February, and the first tankers arrived in early February . Freeport's operator hopes to speed up regulatory approval for restarting commercial operations , at 1/4 capacity. The prevailing sentiment now is that Freeport will be ready for full export capacity again in 2H23.
We expect natural gas prices to recover by the end of this year, 2023. We estimate a price at or above $5.00/MMBtu with seasonal surges as the weather gets colder in the latter part of the year. With demand surging, global growth in LNG transport capacity will be limited compared to previous years . FY23 expansion to the global LNG chain is expected to be the lowest since 2013, adding only 1 Bcf/d in capacity. At the same time, domestic consumption of LNGs is expected to surge to record highs in January 2024. The EIA estimates a domestic natural gas demand of 86 Bcf/d, with natural gas remaining roughly 40% of US electrical generation into 2024. Thus, it is unlikely to us that the 70% price collapse of natural gas in the last 6 months will last for very long.
US LNG is in demand as a result of the European Energy Crisis. LNG exports have reached global highs, with an average of 11.8 Bcf/d (billion cubic feet per day). This is a 10% increase from 2021 and a 70% increase from 2019. In January of FY23 Europe experienced historically high winter temperatures , which significantly dampened the demand for natural gas. This dampening pushed gas prices back down to what they were before the invasion of Ukraine. However, natural gas exports are nonetheless expected to increase yet again as the war in Ukraine drags on and as an additional 8-10 Bcf/d in expected US LNG capacity comes online by 2026. This demand should be creating a strong back for natural gas prices.
Financials
CRK's high free cash flow generation allowed the retirement of $506 million of long-term debt, to 1.1x debt-to-EBITDA. The remaining debt on the books matures in 2029.
Operating Costs Per Mcfe / EBITDAX Margin (CRK 4Q22 Report)
Limited hedging of only 47% of production and favorable pricing allowed CRK to participate in the natural gas price surge midyear. 4Q22 Year over year, FCF increased by 22% to 129 million and EPS by 184% to $1.05. Pricing is much lower than in the middle of FY22, and FCF will probably decline in early 2023. But, as we have said previously, this is likely to be a temporary slump.
Risk and Conclusion
Price is the most glaring risk as the natural gas price per MCF has fallen to an unfavorable level below $3. If the price were to stay at these levels as hedges roll off, FCF would get crushed resulting in slow or no additional debt repayment. However, debt is not really a problem given how much was repaid in FY22. Currently, CRK has plans to retain the dividend even in a lower price environment.
Historically when companies had high prices and lots of cash flow, they invested heavily and with leverage. The past couple of down cycles bankrupted many companies and made the survivors more conservative. Hence in the aggregate, there is not enough capital going to development meaning supply will not overshoot demand and high prices are more sustainable. An adverse regulatory environment has also starved the industry of capital. Higher prices are the result and will make the industry less boom and bust. Dividend payments instead of Capex are drawing the ire of Washington but are favorable to shareholders as the use of capital for dividends makes high prices more sustainable and thus the dividends more sustainable than past cycles.
CRK is immensely cheap, likely because of the 70% slump in natural gas prices over the last 6 months. CRK generates a huge amount of free cash, has a geographically advantageous position, and has a strong balance sheet and sector-best cost structure.
For further details see:
Comstock Resources: 3.8% Dividend Yield And 7-10% Growth