What Is The Problem With Coterra Energy (NYSE:CTRA)

Coterra Energy (NYSE:CTRA) recently reported a bullish quarter. Management even raised production guidance. Yet the stock performance is something else entirely. Much of the industry is in the doghouse. So, the question remains if this is one of those that will recover to lead the industry (or will it continue to lag?). What many do not realize is that even after the merger, this is essentially two separate companies under one umbrella. What used to be Cabot is a cash flow subsidiary that can be used to explore a lot of acreage that the other company Cimarex brought to the merger. Much of the Cimarex acreage was thought (at the time) to provide the potential for a far more valuable liquids revenue than was the case for the Cabot acreage. Nonetheless, Mr. Market always compares and looks to see if every penny is accounted for.

Natural Gas Prices

Natural gas prices are definitely weak and dry gas production has been declining. It is only a matter of time before the excess natural gas in storage gets to a level where natural gas prices begin to recover. Aiding the natural gas situation is a fair amount of exporting capacity that comes online this fiscal year and next fiscal year.

Nonetheless, the market looks at prices received.

Now the oil prices look reasonable (or at least “in there”). But the Marcellus natural gas price received has long been an issue for Cabot. Cabot has been known to depend upon the acreage to produce good results and then largely avoid the issue of making more money on natural gas prices.

The reason is that management never put much, if any effort, into getting the natural gas out of the oversupplied Marcellus area. Afterall, if profits were already good and shareholders were happy, then why bother?

Antero Resources Prices Received

Many have noted great margins and other features. But in the commodities business, every penny is important. There are different sales terms due to when possession is taken of the natural gas by the seller that will account for some pricing differences. But there is also a difference in prices received by getting the natural gas to a stronger priced market.

Generally speaking, natural gas transportation is not all that much when compared to the price of natural gas. Antero Resources (AR) management has long dedicated themselves to getting the best price for their production as long as the net amount is greater than the price received in the Marcellus Basin. As shown above, compared to the price that Coterra is earning for its natural gas, that is very likely to be the case. This management has long had the choice to sell in the Marcellus Basin or elsewhere and has long chosen to sell elsewhere.

In an industry where every penny counts, the difference in what the two companies receive for natural gas shows a lot of potential pennies for Coterra to collect.

It should also be kept in mind that net income and cash flow are fractions of revenue. Therefore, every extra little bit that management can get flows through to shareholders. Therefore, you have to ask yourself if “good enough” is all you want as a shareholder or if you want every last penny you can get.

Company Sales Profile

Sure enough, management admits to selling some gas in the basin combined with some power sales that are at a premium to the basin price. However, the problem with that “premium” statement is that the Marcellus Basin prices are typically at a discount to just about any reasonable benchmark chosen. That begs the question of “the real premium” compared to some benchmarks that others use.

This company is now large enough, that frankly, those discounts shown above far more likely belong to smaller operators. Hopefully the company has taken measures to benefit from the climbing ability of North America to export natural gas.

Antero Resources, in contrast, regularly notes that none of its production is ever sold within the basin. In fact, management has been criticized for maintaining “extra” transportation capacity for which many thought the company would lose money. Yet quarters keep going by where that pricing premium usually exceeds nearly every producer in the basin by more than the amount it takes to maintain transportation choices.

Now, the company appears to be heading towards an export policy for the foreseeable future because that is where the constant premium is. Here, with Coterra, that discount takes away from hard earned production value.

What Can Happen

Whenever there is a situation where management settles for “good enough” there is a market inefficiency that is likely to be corrected overtime. Now the process is “messy” in that it may happen tomorrow or long into the future. But it usually will happen.

The case of Exxon Mobil (XOM) acquiring Pioneer (PXD) is probably an excellent example. Right away Exxon Mobil figured there were efficiencies to be gained as Pioneer Resources management had long been known to settle for “good enough”. Pioneer had some of the best leases in the Permian. Therefore, good results were assured even if management did not go for “every last dime”.

But upon acquisition, both in the presentation and later during several conference calls, management at least implied much better well efficiencies lie ahead which implied greater production. Exxon Mobil also has a current program underway to get a lot more out of Permian wells through secondary recovery in the future.

What is now coming to the forefront is that while Pioneer shareholders definitely had a satisfactory return, there was clearly a fair amount of improvement available that there was no drive to achieve for shareholders because current results made shareholders happy.

Another example was the Rice Brothers’ battle to win control of EQT (EQT) back in 2019. Poor operational results were a key focus of the battle. The latest acquisition of Equitrans Midstream (ETRN) was both to get more natural gas out of the basin for a better price while touting that the company breakeven could drop as much as 25% (give or take) as a result of the acquisition. This continues a history that began with the Rice Brothers at the helm of the company, of dropping company breakeven costs. This results in a far more profitable company now than was the case before they took over.

Summary

Coterra Energy has a lot going for it. But the apparent focus on oil has missed a decent profit opportunity in the form of natural gas prices generated. The commodity business is such that every last penny of potential profit is important. That requires a detail oriented and driven management. There are signs here that this management at least in part does not meet that objective.

When that happens, the market often assigns a long-term discount because a “good enough” attitude is associated with more future challenges that a detail-oriented and driven management is expected to uncover before it becomes a problem.

Some have long speculated, for example, that EQT was headed towards a much more difficult fiscal year 2020 than what actually happened. There are similar speculations about what the Pioneer profits could have been with an Exxon Mobil management attitude.

Management plays an important part of a stock price evaluation and the potential for overlooking future issues is a fair part of that stock evaluation. Therefore, for me this is at best a hold because I am a firm believer in detail-oriented and driven management.

This management could well end up benefitting from the coming natural gas price recovery. But it appears clear that it could benefit far more.

The website shows a total return of about 70% since the last article was written back in July 2021. From that time period forward, the EQT return (for example) was similar. But now EQT management states that the latest acquisition (which dropped the stock price temporarily) will drop the company breakeven by a sizable amount. Coterra has really nothing of that significance going forward. Both are likely to benefit from the coming natural gas price recovery. But EQT appears to benefit both from the pricing recovery and significantly lower costs in the future.

Risks

Any upstream operation will have exposure to volatile and low visibility future commodity prices. A severe and sustained downturn of those prices could result in a very different future than what was implied above.

The loss of key personnel could set back the company’s future plans materially.

This company is diversified by operating in a number of basins with the potential to enter still more basins in the future. That reduces the risk of a technology improvement that switches the location of the low-cost basin.

Additionally, technology advances that periodically sweep the industry can result in an unfavorable change in the company competitive position. Keeping up with the latest advances as well as having acreage that takes advantage of those advances can be quite a task for any management.