DNY59 Introduction – The economics look good
The Marcellus Shale is situated in Pennsylvania and Range Resources Corporation (NYSE:RRC) has its operations concentrated here. The stock has been on a roll lately and there is positive commentary surrounding it, which makes us want to go with the flow. Everything we’ve seen so far on the company has exceeded our expectations. Revenue and free cash flow have skyrocketed over the past three years. The company reported $1.15 billion in annual net income for 2022 and so it has been productive considering that $460.7 million was spent to drill 60 development wells. What is more, the drilling activity only keeps rising as seen in the table below.
RRC Annual Report 2022
Add to this the fact that there is a lot of capacity yet to be utilized and we have a situation where a remarkable growth story may unfold. Presently, there are no proved undeveloped reserve locations planned to be drilled after the expiry of the lease. RRC – Annual Report 2022
Sales have tapered down the last quarter, but this is because of the lower prices of natural gas. Commodity prices have actually been rather low throughout the year. Efficiencies and timing of activity have been positives coming out of the recent earnings call. With energy prices at elevated levels, investors have every reason to be bullish on this natural gas stock. The growing buyback program and dividends paid over the years make it all the more attractive. As you go through this article, you will see that the fundamentals are such that the capital distributions to shareholders is likely to go up even more. By the looks of things, the spiraling energy prices are going to be a thing going forward and this will put RRC into an even better position. As we mentioned earlier, dividends and buybacks may get boosted singularly as a result of this. So a lot of cash could line shareholders’ pockets. We want to point out that the dividend payout ratio is just 10.49% and so there is immense room for growth in this avenue. The 5 year growth rate is 31.95% and therefore justifies the A+ rating for the stock. The growth in dividends appears to be a recent phenomenon. Consequently, investors should see this as an opportunity especially since dividends have been paid out with a record growth rate during the last year. Everything points to the dividend being super safe, but this is not the reason to consider the stock in your portfolio. It is the capital gains that could be significant in the next few years that have us bullish.
Google Finance
The stock has done exceedingly well in long-term charts. Google Finance
Range has been committed to operating efficiently and therefore its operating expenses are lower than its competition. EPS has beaten estimates by some distance over the past four quarters. In fact, Range Resources has grown its EPS from $2.16 to $7.03 in only a year according to Simply Wall Street. EBIT margins soared to 56% last year.
Successful drilling program Total proved reserves gained 2% in 2022 versus 2021, from 17.8 Tcfe to 18.1 Tcfe. This increase reflects the efficient development and quality production. As long as reserves are growing at a healthy pace, it bodes well for the company’s future. However, there has been a slight drop in production with daily production averaging 2.12 Bcfe per day in 2022 compared to the 2.13 Bcfe daily in the prior year. Nonetheless, overall the production activities stats have been nothing short of outstanding. Last year, Range drilled 60 gross natural gas wells with the success rate at 100%. Activity levels are high and you will see later that steps have been taken to curtail debt, which makes for a two-pronged upbeat case right there. As selling prices are weak, it makes sense to take this approach for Range management.
Natural gas demand outpaces supply Natural gas demand is forecasted to really grow based on article by SA Analyst Leo Nelissen. The piece mentions that the progression will persist into the late 2030s. The gas flows from Russia to Europe have been stopped momentarily, leading to the U.S. becoming the primary source for natural gas. Energy demand will persist given the strong middle-class growth in emerging markets with China even endeavoring to halt new coal plants completely in a gradual process. In the US, coal power stations continue to get shut down and there is shift to gas-fired generation. The scale and demand of Range Resources gives it a competitive edge and there is definite pricing power. With rig counts falling, we expect Range to take full advantage of the growing excess demand. There is also the situation where cost savings will be realized with any new wells completed.
Natural gas prices are going to continue to soar in the foreseeable future The best buying opportunity may have been in June when natural gas prices had bottomed. However, it has been a down year for natural gas prices and its ripe for the picking still. EBITDA has been recorded at $1.93 billion for 2022. Going by TTM, the figure has swelled to $2.57 billion so far. Free cash flow has gone from a negative value three years ago to an impressive $1.37 billion, boosting valuations. It is anticipated to have similar FCF figures this year by the TTM values. In the coming natural gas price recovery, we expect profits to go up considerably.
Debt reduction Range lowered net debt by over $860 million in FY 2022, representing around half of yearly cash flow. This was a record for the firm with debt reduction being the largest capital allocation category in the financial year. While Range has some way to go to hit its target net debt level of $1.0 to $1.5 billion, the energy company shareholders will be pleased with the value that currently stands at $1.87 billion. The Company’s targeted debt balance is in keeping with the goals it has set for itself. Commodity price cycles are inevitable in the energy business and having a solid foundation will ensure that RRC is both resilient and opportunistic. Controlling costs has been identified as the primary means to boost long-term shareholder value.
Financial flexibility Leverage-wise, RRC’s Total Debt to Total Equity ratio is lower than competitors like Antero Resources (NYSE:AR). Being at the lower end of what is considered a good debt to equity ratio, RRC enjoys an enviable position after considering the encouraging growth metrics. The 3-year revenue CAGR of approximately 20% and a 5-year CAGR of 14.37% are quite solid. Range ended 2022 with robust liquidity with a credit facility of $1.2 billion available.
Institutional buying In the last quarter, there has been a lot of buying activity on the stock. Price T Rowe Associates, Vanguard Total Stock Market Index Fund Investor Shares and iShares Core S&P Mid-Cap ETF were some of the major shareholders increasing their portfolio allocation in RRC.
Risks The highly volatile natural gas market is a downside. The question arises whether you can even consider RRC as a value play given this aspect. One of the biggest risks is that the EIA has dropped its 2050 LNG demand projections by approximately 15% and general natural gas demand by 20% in the latest report compared to its 2021 forecast. There is also the likelihood that natural gas prices could fall. This may be a plausible scenario due to the fact that prices are at rather high levels at the moment. The current market prices are beyond the control of the firm too. Since RRC hedges for gas prices, there is the chance that it will not rally as much in a bull market. There is the real issue as well that the market may have priced the considerable growth story of Range into its current trading price. After all, sustaining the remarkable single year EPS growth is no easy feat.
Valuation The Marcellus Shale drilling area is considered a real gold mine and we will factor this in our revenue and EBITDA forecasts. Natural gas is highly demanded at the moment and the figures reflect this. At the moment, earnings and EPS are doing well. We tried our hand at a DCF valuation as outlined below. We are quite optimistic on the company’s earnings forecasts given the tailwinds and we will go with strong…
