2023-05-15 17:43:48 ET
Summary
- Comstock Resources, Inc. is an independent E&P that operates in the Haynesville Shale.
- The price of natural gas has fallen substantially this year due to a supply glut, and it does not appear that this is likely to change in the near term.
- The low prices are dragging on Comstock Resources' financial performance and stock price, but the company is taking steps to handle the problem.
- The company has a reasonably strong balance sheet and reasonable debt load, so it should be able to weather the current environment.
- The company is currently trading at a very attractive valuation.
Comstock Resources, Inc. ( CRK ) is an independent exploration and production company that produces natural gas in the Haynesville shale. This is not a basin that we hear about very often, but it is the third-largest source of natural gas in the United States. Unfortunately, Comstock Resources' focus on natural gas has not benefited it very much this year as natural gas prices have been incredibly weak since the start of the year. In fact, natural gas at Henry Hub has declined 50.22% year-to-date:
This was mostly due to a supply glut that was caused by an unusually warm winter that reduced domestic demand significantly. However, the long-term fundamentals for natural gas are quite positive as the compound is likely to see significant demand growth as a supplement to renewable sources of energy. While this will certainly work to Comstock Resources' benefit over the long-term, the company will likely continue to struggle for the near future as there are signs that the United States will soon fall into a recession as there is no immediate source of demand to offset the current source of oversupply. Fortunately, the company does have a reasonably attractive valuation at the current price and a reasonable dividend yield, so investors are paid while the long-term thesis plays out.
About Comstock Resources
As stated in the introduction, Comstock Resources is an independent exploration and production company that primarily operates in the natural gas-rich Haynesville Shale. The company controls approximately 470,000 net acres in both the Texas and Louisiana portions of the resource play:
Comstock Resources
The Haynesville Shale is not a region that we hear much about in the media, but as was already mentioned, it is the third-largest natural gas play in the United States. According to the U.S. Energy Information Administration , the Haynesville shale has proved resources of 56.2 trillion cubic feet of natural gas as of 2021. That is more than any other basin in the country except for the Marcellus and the Permian Basins.
This incredible resource wealth is reflected in Comstock Resources' reserves. Many investors overlook an energy company's reserves, which is a mistake as they are critically important. This is because the production of crude oil and natural gas is by its very nature an extractive process. After all, resource producers literally obtain the products that they sell by pulling them out of reservoirs in the ground. As these reservoirs only contain a finite quantity of resources, a resource producer must continually discover or acquire new sources of resources, or it will eventually run out of products to sell. As a company's success in these endeavors is by no means guaranteed, its reserves dictate how long it can continue to produce before it ultimately runs out of resources. As of January 1, 2023, Comstock Resources had total proved reserves of 6.7 trillion cubic feet of natural gas equivalent. The company was producing an average of 1.4 billion cubic feet of natural gas equivalent per day as of that date, so its reserves were sufficient to last for just over thirteen years. That is a very reasonable reserve life that is actually better than many of the supermajor energy companies possess. As such, Comstock Resources appears to be quite well positioned here and should be able to operate for quite a while even if it fails to discover new resources for a little while.
With that said Comstock Resources does have a history of growing its reserves, which is at least partly because the increasing efficiency of drilling operations has been rendering more resources economically viable. As we can see here, the company's reserves went from 6.1218 trillion cubic feet of natural gas equivalent to 6.7009 trillion cubic feet of natural gas equivalent last year:
This is despite the fact that the company was extracting natural gas out of the ground all last year. This is a good sign, particularly should it continue, as it ensures the long-term viability of the company. Unfortunately, as Comstock Resources only releases estimates of its reserves annually, we do not know what has happened over the first several months of this year as far as this goes. Nonetheless, the point is made as the company is incredibly wealthy in terms of the resources that it has in the ground. This is one thing that we very much like to see with a company such as this.
As already mentioned, natural gas has performed rather poorly this year. This is due to an oversupply of natural gas in the United States after a fire shut down a major natural gas export facility and an unusually warm winter caused natural gas consumption to be lower than normal. This has had a negative impact on Comstock Resources' stock price, as might be expected. The company's stock is down 22.70% year-to-date, so it has fortunately held up better than natural gas prices have:
This is completely expected in such an environment, however. As anyone that has been following the energy industry for an extended period of time is well aware, stock prices of energy companies tend to correlate with crude oil and natural gas prices. This is partly due to the fact that the financial performance of these companies is somewhat dependent on resource prices. We can see this by looking at Comstock Resources' operating cash flows. Here they are:
As we can see, the company generally did better during periods in which resource prices were higher, although it is not a perfect correlation. One of the reasons for this is that the company uses hedging to manage its exposure to commodity prices. Basically, it is using futures, forward contracts, options, and other derivative contracts to essentially lock in a price for the natural gas that it sells. In the first quarter of 2023, Comstock Resources realized an average selling price of $3.07 per thousand cubic feet of natural gas equivalent despite the fact that the average market price was $2.98 per thousand cubic feet of natural gas equivalent during that quarter. The company was able to accomplish this because it purchased the derivative contracts in advance, well before the price of natural gas started declining in earnest around the start of this year. This is how it can help smooth out the company's revenue and by extension profit and cash flow. The company's selling price in the first quarter of 2022 averaged $3.53 per thousand cubic feet of natural gas equivalent despite the average price during that quarter being $4.55 per thousand cubic feet of natural gas equivalent. Thus, the hedging program allowed the company to enjoy more financial stability than it otherwise would have experienced. However, as not all of the company's production is hedged, it does still have some exposure to natural gas prices in either direction. Thus, it seems likely that its performance over the rest of this year will be worse than the company managed to deliver over the course of last year, barring a substantial improvement in natural gas prices, which seems unlikely.
Comstock Resources, along with a few other producers, is taking steps to reduce the current oversupply of natural gas. A recent report from Baker Hughes pointed this out, as exploration and production companies pulled sixteen drilling rigs from productive duty last week. That brings the total number of rigs in operation nationwide down to 141, which is the largest weekly decline since February 2016. As some readers may recall, 2016 was the tail end of one of a rather nasty bear market for the energy industry caused by the Saudis attempting to bankrupt the U.S. shale industry. The fact that last week was the largest since that event certainly says something! Comstock Resources itself stated that it will be reducing drilling activity in the Louisiana portion of the Haynesville Shale. Depending on how this plays out over the rest of the year, it could represent a reversal from the company's recent history of delivering fairly aggressive production growth:
Comstock Resources
However, it is probably best for the company to reduce production until natural gas prices recover. As I have pointed out in various past articles, energy price changes are usually more important for a company's bottom line results than raw production. It will also increase its profit margin if prices go up, which is highly unlikely to happen as long as the supply glut persists.
Financial Considerations
It is always important to look at the way that a company finances its operations before considering an investment in its shares. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. That is usually accomplished by issuing new debt and using the proceeds to repay the maturing debt. This can cause a company's interest expenses to increase following the rollover, depending on the conditions in the market. When we consider that interest rates are at the highest levels that we have seen since 2007, that is a very real concern right now. In addition to this risk, a company must make regular payments on its debt if it is to remain solvent. As such, an event that causes a company's cash flow to decline could push it into insolvency if it has too much debt. This is also a risk that we should not ignore in Comstock Resources' case due to the volatility and weakness in natural gas prices right now.
One metric that we can use to measure the debt level of an exploration and production company like Comstock Resources is the leverage ratio. This ratio is also known as the net debt-to-EBITDAX ratio, and it essentially tells us how long (in years) it would take the company to completely pay off its debt if it were to devote all its pre-tax cash flow to that task. We explicitly exclude exploration costs here as it gives a better picture of the company's actual cash flow as it can capitalize costs associated with exploration. As of March 31, 2023, Comstock Resources had a leverage ratio of 1.1x based on its trailing twelve-month EBITDAX. I will admit that I would prefer to see this ratio below 1.0x, but the current ratio is not too bad since Comstock Resources does not have any debt due until 2027:
Comstock Resources
Thus, Comstock Resources, Inc. has plenty of time for natural gas prices to recover before it needs to worry too much about its debt. As there are several natural gas liquefaction plants coming online by that time that will serve as a source of new demand, it seems likely that it will be able to realize higher prices by that time and possibly even pay down its debt somewhat before it needs to roll it over.
Valuation
It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of an independent exploration and production company like Comstock Resources, we can value it by looking at the stock's forward price-to-earnings ratio. This ratio basically tells us how much we have to pay today for each dollar of earnings that the company is expected to generate over the next year. As I pointed out recently though, pretty much everything in the energy sector is substantially undervalued today. Thus, it is best to compare Comstock Resources to some of its peers in order to see which stock currently offers the most attractive relative valuation.
According to Zacks Investment Research , Comstock Resources has a forward price-to-earnings ratio of 8.48 at the current price based on its current year estimate of $1.16 per share. This is substantially less than the 18.17 ratio of the S&P 500 Index ( SP500 ). Here is how Comstock Resources' ratio compares to some of its peers:
Company | Forward P/E Ratio |
Comstock Resources | 8.48 |
Range Resources ( RRC ) | 11.08 |
Antero Resources ( AR ) | 12.89 |
EQT Corporation ( EQT ) | 12.49 |
Chesapeake Energy ( CHK ) | 15.96 |
As we can clearly see, all of these companies are valued somewhat more cheaply than the market in aggregate right now. However, Comstock Resources is by far the cheapest of the group. This could certainly appeal to value investors, although it does seem likely that the stock will struggle for a while due to low natural gas prices.
Conclusion
In conclusion, Comstock Resources, Inc. has certainly taken some punishment due to the very low natural gas price environment. The company's hedges are helping it somewhat, but it does seem very likely that its financial performance this year will be much worse than what the company managed to achieve in 2022. It is actively working to reduce its natural gas production though, which is probably a good idea until the supply glut abates. The long-term story that we have established for Comstock Resources, Inc. in previous articles remains intact and it is probably worth it for long-term investors willing to be patient, but it is important not to expect anything incredible in the near term.
For further details see:
Comstock Resources: Low Gas Prices A Drag, Nothing Remarkable In The Near Term