Investors are taking a "wait and see" attitude toward shares in the top U.S. natural gas producer, Appalachian shale driller EQT Corp., after the stock popped 10% on Feb. 15 when the company announced it would solve its lingering "sum-of-the-parts" problem by the end of February instead of March.
EQT's share price was down almost 2% in light trading on the morning of Feb. 20, to $51.48.
Long before it supersized itself with the purchase of neighbor Rice Energy for $6.7 billion in November 2017, EQT was a herd of moving parts: The upstream drilling unit had midstream assets; parent EQT controlled an affiliated gathering and processing master limited partnership, EQT Midstream Partners LP; and a separate company held the 2% general partnership of EQT Midstream, EQT GP Holdings LP. While EQT Midstream and EQT GP both had stocks to reflect their value and pushed some cash back to the parent EQT, the sum of EQT's interests in this collection of partnerships and operations did not seem to equal the value of the parts.
Buying Rice tossed more partnerships and assets into the EQT complex: Rice Drilling B, Rice Midstream Partners LP and Rice Midstream Holdings, parts that may or may not add up for buyers of EQT stock.
While there are operational advantages for an upstream producer using a controlled affiliate to provide midstream services, SunTrust Robinson Humphrey oil and gas analyst Welles Fitzpatrick said the two functions make "awkward bedfellows."
"Midstream and E&P [exploration and production] assets and investors are very different, because assets have different valuations and risk profiles," Fitzpatrick said in a Jan. 31 presentation. "MLPs' long-term driver is yield; E&Ps long-term driver is growth."
Most analysts expect shares in upstream-only EQT to jump higher when the reorganization is complete and the E&P business is unhooked from the midstream pipelines and processing plants.
"Yesterday's +10% move just the appetizer, entrée coming with full [sum of parts] resolution," analysts at energy investment bank Tudor Pickering Holt & Co. said Feb. 16. "Opportunities like this come few and far between — we are aggressively buying today."
Investors are also looking forward to the cash that will flow back to parent EQT as the reorganized midstream company or companies pay for an estimated $1 billion in assets as they are "dropped down" from EQT, cash that could continue become bigger dividends or buybacks of what analysts say is an underpriced stock.
"Tax reform has swung 2018 from a marginal outspend year to generating ~$300 million of [free cash flow] at strip [prices]," Tudor Pickering Holt said. "We would love to see the company use this and $1 billion coming from midstream dropdowns to repurchase shares given the deep intrinsic discount to fair value."
According to discussions Jefferies LLC analyst Mark Lear said he has been having, a stock buyback is in EQT's plans. "While EQT management did not shed any light on progress of those plans to date, discussions we have had would suggest expectations that proceeds from [a Rice Midstream Holdings/Rice Midstream GP Holdings LP] drop would be used to buy back shares, likely after a tax-free spin of EQT's [EQT GP] position," Lear told his clients Feb. 16.
"Our read from the call is the plan is in place, can be implemented faster than expected, and looks better versus prior plans with tax reform boosting the outlook," Wolfe Research LLC oil and gas analyst Josh Silverstein said Feb. 15. "We remain outperform rated and still see the same 3:1 risk/reward opportunity in front of us even after today's move."