2023-03-10 03:02:11 ET
Summary
- Coterra's management team plans to deliver the lion's share of cash flows back to shareholders.
- The company has improved its revenue mix by increasing the amount of oil vs. natural gas produced.
- Coterra is a low-cost producer that we think dividend investors shouldn't gloss over.
Background
Despite strong inflationary pressures in 2022 that decimated most of the market, the Energy sector fared quite well. Over the last 12 months, an investment in the SPDR Energy ETF ( XLE ) returned 40%, vs the S&P 500 ( SPY ) return of -12%.
The energy sector had a number of other tailwinds pushing it along including production spates between OPEC and the Biden administration and the Russian Invasion of Ukraine. The sector has shown, however, resilience in the face of inflation and stands to gain from a confluence of other factors in the coming year as well. These other factors range from the re-opening of China's economy from zero-COVID conditions to the continued reticence of American producers to increase output.
Against this backdrop, we like energy producer Coterra Energy ( CTRA ). Formed in 2021 in the merger with Cabot Oil and Cimarex, CTRA stock sports a 10.5% dividend yield as of this writing.
Coterra produces both natural gas (about 85% of its business) in the Marcellus Shale region of Pennsylvania. The remaining 15% of business is generated from oil in the Permian Basin and Anadarko basin.
The company is highly profitable, generating significant cash flows--it's estimated to have kicked off $3.9 billion in 2022--of which the majority will be returned to shareholders.
The dividend also appears to be sustainable when the considering the company's capital structure. Management runs a lean operation--Coterra has one of the lowest net leverages around, with a net debt to TTM EBITDA ratio of 0.2x.
Add in the production rates of its oil and gas properties, and Coterra looks to have a recipe for success. The biggest question in the minds of investors, of course, is likely to concern the price of natural gas, given that it is the source of 85% of the company's revenue.
The above slide details estimated production and profitability of Coterra's newest natural gas development, the Upper Marcellus field in Pennsylvania. In the estimate, the company states that with a flat price assumption of $4.25/mcf, the wells will turn a profit. (Note that this isn't the company's breakeven price, but simply a profitable level to compare the Upper and Lower Marcellus fields.)
The next question, of course, is are we likely to see natural gas prices support that assumption or anything close to it in the near future? After all, forecasts for natural gas prices show a significant drop in the near-to-medium term.
According to the U.S. Energy Information Administration, yes.
From the 2022 peak of nearly $9 per m/BTUs, price is expected to level off around the $5. While these forecasts are not always accurate, they are not back-of-the-envelope calculations, either, as they take into account a robust amount of forecasted consumption and production capacity.
Coterra recently released its annual results and disclosed that it sold its natural gas (once hedges were taken into account) for an average of $4.91.
Among energy players, we believe Coterra is well-positioned to reward dividend investors, both for its outlook and its shareholder-friendly management policies.
Not Just Gas
One critique against Coterra in days past was that the company was too heavily buoyed in natural gas. Given that gas has spent a long time (prior to the last two years, anyway) at prices where it was effectively cheaper to leave it in the ground than pull it out, this made sense.
The company, however, has taken drastic steps in 2022 to expand its oil reserves and production operations.
Income Statement (Company Presentation)
In 2021, the company generated $2.7 billion from its natural gas operations (centered heavily in Pennsylvania), and only $616 million from its oil operations in the Permian and Anadarko basins.
2022 saw very different revenue mix--the company grew its oil revenues by over 300% to $3 billion. This was something we had been on the lookout for, as the collapse in natural gas prices from dizzying highs was a worry for Coterra shareholders, given the high exposure of the company to natural gas.
Potential investors, however, are likely to react to this new oil revenue by saying that, sure, the increase is all well and good, but is it sustainable?
While we can't predict what oil prices will be in the coming year, we can say that Coterra's proven oil reserves have grown in the last twelve months. In 2021, the company reported proven oil reserves of 189,429 MBbl of oil. In 2022, that figure grew to 239,755 MBbl. Given that the company has consistently (and wisely, in our view) hedged its output, we think that the company will be able to take a lot of price risk off the table.
With implied inventory duration of around 15 years on average (and with the Permian making up the longest-duration asset), we feel relatively comfortable that Coterra will be able to keep pumping consistently into the foreseeable future.
The Bottom Line
It wasn't that long ago that it was popular to declare that the world had hit 'peak oil'. That is, that civilization had reached the pinnacle of volume usage of petroleum products and natural gas. With EVs and various other forms of power generation in storage coming online over the next decade or two, there may be some truth to this claim.
The Russia-Ukraine war, however, proved definitively that even if we had reached so-called peak oil, the price of the oil we do use can rise very high very fast.
With management's strong desire to deliver value back to shareholders, valuable natural gas and oil reserves in high-producing fields, and a low cost of production, we think that Coterra deserves serious consideration from investors when looking for energy stocks to add to their portfolio.
For further details see:
Coterra: Why This High-Yield Energy Stock Deserves Your Attention