Portfolio Review: Natural Gas Producers

Over the remainder of this month, I will be evaluating the portfolio holdings and making recommendations on which holdings I consider to be the current Best Buys in each group. I have divided the holdings into ten categories. 

There are 13 companies classified as oil and gas companies. Five of those companies are predominantly natural gas producers. I want to begin the review by looking at the companies in that category. Here are those holdings, along with some key metrics for each company:

  • EV – Enterprise value at the close on October 9, 2017
  • FCF – Free cash flow
  • TTM – Trailing twelve months
  • EBITDA – TTM earnings before interest, tax, depreciation, and amortization
  • EV/Res – Enterprise value divided by the total proved reserves in barrels of oil equivalent at year-end 2016
  • YTD Ret – Year-to-date total shareholder return through October 9, 2017 

Below is some commentary on each company.

EQT Corporation (NYSE: EQT) has been a leading Marcellus driller with extensive holdings in the basin’s liquids-rich sweet spot. But with the acquisition of Rice Energy (NYSE: RICE) announced in June (See Rice Energy Soars On Buyout), the combined company will be the largest natural gas driller in the U.S. 

EQT has been an enthusiastic developer of affiliated income vehicles, spinning out first its midstream operations and then its general partner interests in those as separate securities. These interests and EQT’s strong balance sheet give the company an advantage over some of its Marcellus competitors. EQT will be a significant beneficiary of the eventual recovery in natural gas prices, not least because its midstream MLP is getting an increasing share of its pipeline traffic from other nearby producers.

EQT was the largest company on the list even before the merger (which has yet to close) but is cheap from an EV/reserves and EV/EBITDA measure. It also has a strong balance sheet with modest debt. According to the subscription-only S&P Global Market Intelligence database, in 2016 EQT’s production cost was only $0.23 per thousand standard cubic feet (Mcf) of natural gas. I consider EQT the second-ranked Best Buy among the natural gas producers in the portfolio.

First place goes to the second largest company on the list, Cabot Oil and Gas (NYSE: COG). Cabot is also one of the top natural gas producers in the country, with operations in the Marcellus Shale in northeast Pennsylvania and the Eagle Ford Shale in south Texas. In 2016, Cabot produced more free cash flow (FCF) than any other natural gas company on the list and was only one of two companies to generate positive free cash flow.

Cabot has the least relative debt in the group, and its reserves are priced below the group average. The one negative is that its EV/EBITDA is the highest in the group. Nevertheless, Cabot is the lowest-cost producer in the Marcellus Shale, with a 2016 production cost of only $0.11/Mcf (less than half of EQT’s cost). Given that it has managed to produce FCF in this challenging environment, and maintained a solid balance sheet, Cabot is the top-ranked Best Buy among the natural gas producers.

The other three gas companies in the portfolio all involve special circumstances of one type or another. 

Rice Energy was a portfolio holding before the EQT acquisition, and despite the 28% jump when the acquisition was announced, I recommended that investors continue to hold. Shares have risen another 12% since, and are now close to the Buy limit of $29 a share.

As a result, and given that the merger with EQT should soon close, I would not initiate a new position in Rice at this time. Today, Rice shares are trading at a 4% discount to the terms of the deal (each share of Rice earns 0.37 shares of EQT plus $5.30 in cash per share), and that’s not a large enough discount to appeal to me. 

CONSOL Energy (NYSE: CNX) was a natural gas and coal producer that divested its coal interest into an affiliated coal-mining MLP, CNX Coal Resources LP (NYSE: CNXC). In the process, CONSOL became a natural-gas growth play in the core of the Marcellus and Utica shales. But it maintains the interest in the coal-mining MLP, it has an interest in CONE Midstream Partners LP (NYSE: CNNX), it owns a water transfer and disposal company, and it owns a coal export terminal. 

Despite the move toward becoming a natural gas producer, CONSOL is still priced more like a coal producer. It is cheap by most metrics, yet it was only the second of the five companies listed to generate positive FCF over the past year. The one item of note is that debt is higher than the peer group. While it isn’t a pure natural gas play, there is a lot of value in CONSOL’s businesses. It will probably take a rise in natural gas prices to unlock that value, but this one is worth holding. 

Finally, Peyto Exploration & Development Corp (TSE: PEY) is the only foreign natural gas company on the list. We added it to the portfolio back in 2014 after many years of outstanding performance. (See A Canadian Keeper With Startling Returns for the rationale behind adding Peyto). I noted in a 2015 article that Peyto traded at a premium to its peers, but it had earned that premium. 

Despite its historical performance, Peyto has been the 2nd worst performer in the portfolio since being added. The one-time premium is now mostly gone, as Peyto struggles with low gas prices. The company is also bumping up against takeaway capacity constraints on its gas. Combine that with foreign currency risks and foreign taxes on dividends, and Peyto would be first on the chopping block of this list of natural gas producers. I still think it’s a great company with excellent historical performance, but the Marcellus producers are in a better position.

In summary, my ranking of the gas producers would look like this:

  1. Cabot Oil and Gas
  2. EQT Corporation 
  3. CONSOL Energy
  4. Rice Energy
  5. Peyto Exploration & Development Corp

In the next article, I will rank the oil producers.

Stock Talk



I´m struggling to understand why those companies have performed so poorly even though the price of natgas has improved by almost 50% over the last 18 months. Do you have an explanation for that?
Also, given that Peyto is currently yielding close to 7 % whereas the others are paying (almost) no dividends, would you still put it on the chopping block if you were retired and needed the dividend income? Are there operational issues for PEY? Is the dividend at risk?

Robert Rapier

Robert Rapier

After dropping sharply in 2015, Peyto’s cash flow has been rising. They just confirmed the dividend for the most recent quarter, but the payout ratio has been above 100% in recent quarters. That can’t continue. The main culprit is that natural gas prices are still low relative to 2014, although as you say the situation has improved a lot from early last year.

I think the market is pricing in the potential for a dividend cut. If I had already ridden the decline down, I think I would be prone to hold on. Gas prices will recover, but if the current conditions continue for another year I wouldn’t be surprised to see the dividend get cut in half. I think they will hang in there for another couple of quarters before they resort to that though.

No operational issues that I know about. In fact, production continues to grow briskly.

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