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Investors shun Appalachian gas drillers despite pledges of discipline

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Investors shun Appalachian gas drillers despite pledges of discipline

Investors are not reacting positively to Appalachian shale gas drillers' pledges to cut spending while producing more gas in a glutted market, sending share prices for the top 10 publicly traded Marcellus and Utica shales drillers lower in the new year.

An equally weighted index of the 10 companies' stocks lost 11% of its value in January after losing 21% in 2017, but the average masked huge declines for Range Resources Corp., Southwestern Energy Co. and others. Even market darling Cabot Oil & Gas Corp., which gained 28% in 2017, was not immune to the flu that has infected the sector. Cabot's shares lost 8% in January.

The top U.S. NGL producer, Antero Resources Corp., is a case study in how difficult it is to convince investors that a company has taken the pledge to grow production while spending less. Analysts were pleased with Antero after it laid out on Jan. 29 its five-year plan to chop billions of dollars off its drilling budget while still turning in double-digit percentage growth in gas and liquids volumes.

"Antero now expects to generate $1.6 billion of [exploration and production] standalone free cash flow over the next five years on strip pricing, a sharp departure from the high level of outspend that we've seen in the past," Raymond James & Associates Inc. analysts John Freeman and Rich Eychner said. "Given the recent push for capital discipline and improved corporate returns (as opposed to growth for growth's sake), we think the market will view favorably Antero's more capital efficient manner through which to drive production growth in the coming years."

The market has not shared the analysts' perspective so far. Antero shares have dropped 3% since the announcement and 1.5% in January after sliding 20% in 2017.

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According to Williams Capital Group LP oil and gas analyst Gabriele Sorbara, investors have not changed at all.

"Investors begged for capital discipline and free cash flow, yet they secretly want growth," Sorbara said in a Feb. 1 email. "I think the reduced production growth outlooks have driven the underperformance in names like [Gulfport Energy Corp.] and Range. The E&Ps are stuck in a Catch-22 scenario: As you slow down activity to operate within cash flow, your growth profile and EBITDA drop, driving a more expensive multiple. Also, I believe you are seeing a rotation from the pure-play natural gas names, given the weak pricing, into the liquids and oil names. Clearly this rotation is driven by the improving macro backdrop for oil prices."

Utica driller Gulfport, Ohio's top gas producer and Sorbara's top natural gas pick, lost 17% in January after losing 40% in 2017, echoing large value drops among big national drillers such as Chesapeake Energy Corp. (down 11% in January and 43% in 2017) and Southwestern (down 25% in January and 44% in 2017), as well as Marcellus driller Range (down 18% in January and 48% in 2017).

Some difficulties may be self-inflicted. Range apparently passed up a chance to buy neighboring driller Rice Energy Inc. in 2016, choosing instead to buy into the Cotton Valley trend in a Terryville, La., gas field. What looked like a smart move to diversify away from its southwest Pennsylvania fields with their low local prices, now appears to have been a way to spend more money after well results disappointed.

"For 2018, the company is planning to reduce spending by $329 million, or 26%, to $941 million, while generating 11% annual production growth to ~2,229 MMcfe/d and living within [cash flow from operations]," CreditSights analyst Brian Gibbons said Feb. 3. "The Marcellus will get 80% of the budget and the Northern Louisiana Cotton Valley play will get the remaining 20%, with production growth coming entirely from the Marcellus not just for 2018, but through 2022 as type curves in the Cotton Valley are coming in lower than expected."

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EQT Corp., the suitor that did buy the Rice Energy family of companies, also including Rice Midstream Partners LP, has suffered as well. The Rice merger made EQT the largest natural gas producer by volume in the U.S. but saddled the company with a host of pipelines, processing plants and partnerships — Rice Midstream, EQT Midstream Partners LP, and EQT GP Holdings LP — that it needs to restructure to get the upstream parts of EQT fully valued in the stock.

"The EQT complex is mispriced relative to its [sum of the parts] and expect management's plans to address the discount by the end of Q1'18 to illuminate full intrinsic value," analysts at Tudor Pickering Holt & Co. said Jan. 8 after EQT announced its 2018 plans in December. "We look for the upstream business to re-rate on a standalone basis following the [sum of the parts] catalyst."

EQT's stock lost 7% in January after dropping 11% in 2017. Tudor Pickering Holt is recommending that clients buy the dip to get the bump when the upstream and midstream parts are sorted out.

The only Appalachian driller seemingly immune from the January bug is National Fuel Gas Co., also the only vertically integrated company in the group. National Fuel shares lost 1% in January after slipping 3% in 2017. National Fuel has posted positive cash flows for its past three fiscal years (the company reports its earnings on a nontraditional calendar), and analysts surveyed by S&P Global Market Intelligence expect that trend to continue in 2018.