A new competitor in natural gas

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A natural gas compressor station.

Justin Merriman / Bloomberg

Natural gas prices fell this month, as warmer weather and rising supply eased fears of a global electricity crisis. Natural gas inventories have also stagnated. This gives investors another chance to buy into the industry.

One action to consider is


Coterra Energy

(ticker: CTRA), the product of a merger between two companies focused on natural gas — Cabot Oil & Gas and Cimarex. The new company is more committed than most of its rivals to returning cash to shareholders and is well positioned financially to take advantage of strong demand for natural gas.

This is a unique moment for the industry, after years of drowsy returns for stocks. Shale drilling has exploded over the past decade in the United States and released large amounts of gas, resulting in a surplus that has driven prices down. Producers could never make a lot of money because of the constantly low prices. Then the pandemic brought down US drilling, and it didn’t fully bounce back, even though demand did.

Meanwhile, policies to slow climate change appear to be affecting natural gas prices, both positively and negatively. Gas will eventually be phased out as countries adopt stricter regulations for home heating and power generation. But gas is also a key transitional fuel for the next few years, perhaps more than a decade, as coal disappears and renewables increase.

Gas, which historically has been used primarily for home heating, is now the primary source of electricity in the United States and a growing source elsewhere. A lack of gas supply drove up prices in Europe and Asia last month, leading China to impose restrictions on companies’ use of electricity and bankrupt some companies of European electricity.

Gas consumption “will decrease over the next 10 to 20 years, but the transitions do not happen overnight,” said Gabriele Sorbara, analyst at Siebert Williams Shank. The Cabot-Cimarex merger closed on October 1 and Coterra began trading on that day. It has since fallen about 10% to a recent $ 19.90 as gasoline prices have fluctuated and recently traded lower.

However, the company is poised to make gains. Coterra is now one of the largest producers of natural gas in the United States, with an enterprise value (EV) of $ 17.8 billion. Its earnings before interest, taxes, depreciation and amortization (Ebitda) are expected to rise to $ 5 billion next year, giving it an EV / Ebitda ratio of around 3.5 times. High quality energy actions such as


Chevron

(CLC) and


EOG Resources

(EOG) are trading almost five times. Sorbara believes Coterra can hit $ 32.

Coterra has a sprawling network, with operations from the Permian Basin in Texas and New Mexico to the Marcellus Shale in Pennsylvania. Cabot produced gas exclusively, while Cimarex had a few oil operations, so part of the profits will depend on oil prices. Production is expected to be 87 percent natural gas or natural gas liquids next year, according to Sorbara.

Coterra sets itself apart from other gas producers for several reasons. It only covered 10% to 11% of its 2022 production, compared to an industry average of 64%, according to Rystad Energy. As gas prices rise, these hedges could cause billions in losses next year for some players, while Sorbara expects Coterra’s hedges to modestly affect its profits.

Coterra also has a dividend, unlike competitors such as


EQT

(EQT), which last paid one in early 2020. (EQT says it could relaunch a dividend soon.) Coterra has launched a variable dividend policy, committing to pay at least 50% of the dividend. its free cash flow. In its final quarter, Coterra paid a base dividend of 12.5 cents, a variable dividend of 17.5 cents and a special merger-related dividend. The annualization of fixed and variable payments leads to a dividend yield of 6%. Sorbara sees the yield increase by 9.5% next year and 7.3% in 2023.

These are the “kind of feedback you just can’t ignore,” he says. “After you get a few quarters of this huge dividend, I think you’ll see investors flock to this name. “

Write to Avi Salzman at [email protected]


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