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Q3'19 earnings outlook grim for Appalachian shale gas drillers

In the face of slumping natural gas prices, Wall Street analysts have little positive to say about the stocks of Appalachian shale gas drillers ahead of third-quarter earnings announcements at the end of the month.

After investors fled the sector following second-quarter earnings announcements in the summer, analysts said even those companies that thread the needle of growing production while spending less and generating free cash flow for shareholders are helpless in the face of spot and futures gas prices that stay stubbornly below $3/MMBtu. At some Appalachian hubs, prices dropped below $2/MMBtu in September.

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"We expect the vast majority of gas coverage to move toward maintenance capital (EQT Corp.) or decline (Gulfport Energy Corp., Range Resources Corp., Chesapeake Energy Corp.) as fundamentals remain weak and material capex cuts are needed to balance the market in 2020," the gas analysts at energy investment bank Tudor Pickering Holt & Co. said Oct. 8.

An S&P Global Market Intelligence analysis of analysts' expectations Oct. 16 showed that six of 10 publicly traded Appalachian drillers plan to report less capital spending in the third quarter of this year compared to the same quarter a year ago, but most will not report any positive free cash flow for shareholders. According to a consensus compiled by S&P Global Market Intelligence, analysts expect the biggest spending cut, 55%, to occur at EQT, the nation's largest gas producer by volume, but they also expect EQT to spend $205 million more than it earned in the third quarter.

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Under its new CEO, Toby Rice, EQT has not issued any guidance while it reviews operations. The company said it expects to update 2019 and 2020 guidance on its third-quarter earnings conference call, scheduled for Oct. 31.

"Positive stock performance this earnings season depends on achieving or beating production targets while staying within spending plans and providing incremental constructive details around 2020 plans," Williams Capital Group LP oil and gas analyst Gabriele Sorbara told clients Oct. 15.

Sorbara was gloomy even on Gulfport Energy, which is expected to report the best free cash flow of the group at $106 million after cutting spending while turning to a no-growth maintenance spending plan. "We expect mixed results from [Gulfport] — a beat on production/capex but a miss on cash flow," Sorbara said. "[Gulfport] remains challenged by the depressed natural gas strip prices which results in a lack of appetite from investors."

Gulfport is under pressure from activist shareholders that want to see drilling cut to the bone and cash flows from existing wells funneled their way.

As the stock and bond markets remain closed to drillers needing fresh cash to finance their operations, the pressure to consolidate the sector through mergers and acquisitions, eliminating overhead, increases, analysts said.

"We believe mergers of equals (MOEs) and smaller bolt-ons are attractive structures to consolidate among single basin focused, pure-play [E&Ps, or exploration and production companies]," Morgan Stanley oil and gas analyst Devin McDermott told clients Sept. 26. "While the market has punished large-scale corporate M&A in recent years … we would expect smaller-scale MOEs and bolt-ons to be received positively."

"Our screen suggests Appalachia may benefit most from consolidation given the focus on cost reduction across the basin, along with meaningful potential leverage reduction from mergers," McDermott said, naming some pairings he thought likely between companies with neighboring acreage: West Virginia and Ohio driller Antero Resources Corp. with Utica Shale driller Montage Resources Corp. or southwestern Pennsylvania driller CNX Resources Corp.; the Utica Shale's Gulfport with Montage; or southwestern Marcellus Shale drillers Range Resources and Southwestern Energy Co.

The pain in Appalachia may be just beginning, Goldman Sachs oil and gas analyst Brian Singer said Oct. 4. "There is increased sense among investors that the bottom in E&P equities may be in the next one to two years leading to a preference to hang on until fundamentals improve and the sector becomes less out of favor," Singer told clients.