Will the Bears Devour Cabot Oil & Gas

By Matthew DiLallo - October 24, 2012 | Tickers: COG, CHK, EOG, RRC, SWN | 0 Comments

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I have this friend named Bob and he really likes Cabot Oil & Gas (NYSE: COG).  I like Bob, but we don’t always agree.  I thought I’d drill down into his beloved Cabot and prowl around to see if I sniff up any problems he missed.  No company is perfect and thinking like a BEAR at least alerts you to problems before they cut your portfolio too deeply. 

Brown Dense Dry Hole

According to Southwestern Energy (NYSE: SWN) the Brown Dense is “an Upper Jurassic age, kerogen-rich carbonate source rock found across the Gulf Coast region of the southern United States from Texas to Florida…and has indications that the right mix of reservoir depth, thickness, porosity, matrix permeability, sealing formations, thermal maturity and oil characteristics are found in the area of Southern Arkansas and Northern Louisiana. It has the critical properties necessary to be a successful play and compares favorably to other productive oil plays in the United States. However, it has never been exploited with horizontal drilling technology until now.”

While Southwestern has drilled four wells and will begin selling oil and gas in the fourth quarter.  Cabot recently reported an exploratory dry hole in their last quarterly report that was associated with their Brown Dense/Smackover initial exploratory well in Arkansas.  The $10 million cost associated with it has been written off but CEO Dan Dinges isn’t condemning the play just yet.  While dry holes are to be expected when drilling exploratory wells, if it becomes a trend at Cabot it could begin to ding their bottom line.

Environmental Record is Questionable

Back in 2010 the Pennsylvania Department of Environmental Protection took aggressive action against the company to enforce environmental law.  At the time they suspended review of their new drilling permit applications and ordered the company to plug wells, install residential water systems and pay $240,000 in fines. 

This action followed a failure to abide to a 2009 consent order and agreement with DEP.  Former DEP Secretary John Hanger at the time said that, “Cabot had every opportunity to correct these violations, but failed to do so.  Instead it chose to ignore its responsibility to safeguard the citizens of this community and to protect the natural resources there.” 

The controversial issues surrounding the incident in Pennsylvania cost Cabot more than $8 million in good faith efforts.  Cabot has been open and honest about the whole situation and to be commended for their work to rectify the situation.  While this incident is likely an outlier and not representative of how Cabot operates it is a blemish that gives those against fracking more ammunition and an area that investors need to watch.

Ain’t Cheap!

The company trades at almost 100 times 2012 estimates before dropping to 46 times 2013 and 18.5 2014 estimates.  They trade at 9 times revenue and 18 times cash flow.  There is a lot of growth already priced into shares of a company that’s only grown revenue by a 5% annual clip the past five years.  When you compare them to some of their independent peers they don’t really stand out:

Really Levered to Gas

While peers like Chesapeake are making a concerted effort to grow their liquids production, Cabot is content to stay rather gassy.  You might have heard the news, but there’s a glut of the stuff and companies are forced to drill marginally profitable wells at best these days.  Cabot does have some Eagle Ford acreage via a joint venture with EOG and another joint venture with Range in the Utica as they are looking to grow their liquids production.  Cabot is planning to spend 40% of their capital budget on liquids, but a bulk of their production continues to be dry gas. 

Bottom Line

There is nothing wrong with Cabot; they’re just more levered to gas and not the top operator out there. That doesn’t mean they won’t be a good investment over the long term, especially if natural gas prices rise significantly.  For that side of the story, be sure to check out what friend Bob has to say about the three reasons why you should be a buyer. 

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