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Southwestern misses Q2 expectations, dodges Appalachian shale selloff

Shares in shale gas driller Southwestern Energy Co. escaped the punishment in the market that other Appalachian drillers received after missing expectations, as its second-quarter profits fell short but its cash burn stayed under control.

Southwestern reported second-quarter adjusted income of 8 cents per share late Aug. 3. Wall Street was expecting 16 cents per share in adjusted profits, according to S&P Global Market Intelligence. On a GAAP basis, Southwestern reported earnings of $224 million, reversing year-ago losses of $620 million.

The earnings miss came from Southwestern realizing lower-than-expected natural gas prices. But Southwestern, which laid down all of its rigs for parts of 2016 to ride out a trough in prices, kept spending under control and pleased the Street. Southwestern shares gained a few pennies on a moderate volume of trading by noon Aug. 4, a sharp contrast to other shale gas drillers that suffered double-digit percentage declines after reporting results shy of expectations during this earnings season.

"Southwestern reported 2Q gas pricing of $2.15 Mcf vs. our $2.21 Mcf estimate and consensus of $2.33," Stifel Nicolaus & Co. Inc. analyst Karl Chalabala told his clients Aug. 4. "We estimate 2Q cash burn of $22 million."

Southwestern President and CEO William Way told analysts on an Aug. 4 conference call that his company was setting itself up for what he sees as an inevitable rebound in gas prices, particularly in the Appalachian shales, as pipelines are completed and demand increases.

"Production growth is an outcome of our plans, not a driver for them," Way told analysts. "The billions of dollars being invested in new gas-driven power plants and industrial facilities, coupled with continuing opportunities of increased exports both to Mexico and from LNG are expected to increase demand by over 10 billion cubic feet per day over the next four years."

Associated gas from oil drilling in Texas' Permian Basin will not be able to reliably satisfy this demand, Way said. "In this current oil price environment, and with takeaway solutions from the region being required but not being fully subscribed, we think this supply will need to be supplemented by other regions of dry gas."

Way promised that Southwestern is ready to grow production to meet new demand but would keep spending within cash flow, starting with the third quarter. "Drilling, if you get into a place where you're exceeding cash flow or you get into a place — and we're not there now — but get into a place like back in early 2016 where there is no economics to support drilling and completing wells, [and] gas is $1.70, then you don't drill."

"I think you'll see us as we move into this quarter ... and the quarters going forward, it's all about investing within that cash flow," Way told analysts.

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Brian Singer, oil and gas analyst for Goldman Sachs, said he is going to wait and see. "We are Neutral as we believe confidence in Southwestern's growth versus cash flow outspend (we see 17% /year production growth in 2018-20, but with $0.4 billion outspend) is needed," he wrote.

"Southwestern is very levered to our bullish gas and basis thesis, with significant Gulf Coast and Appalachian in-basin price exposure," Stifel said. "Additionally, the company has seen success with its technology evolution in Northeast Pennsylvania driving higher capital productivity. The free cash flow profile in 2018 forward at strip pricing will improve the balance sheet."

Southwestern's production volumes from the portion of the Marcellus Shale in Northeastern Pennsylvania grew 8% to just over 1 Bcf/d in the second quarter when compared to the same period a year ago. In Bradford County, Pa., near monster wells reported by Chesapeake Energy Corp. in Wyoming County and Cabot Oil & Gas Corp. in Susquehanna County, Southwestern reported the completion of a proof-of-concept well with a 12,000-foot lateral leg and 37 MMcf/d of initial production.

The techniques used on the Seymour 1H well will be passed on to future wells in the northeastern corner of the state. Southwestern is so confident in increased production from the region that it booked another 140 MMcf/d of pipeline capacity to the Dominion South hub near Pittsburgh for an average cost of 10 cents/Mcf, indexed to pricing at the Dominion South.

Production volumes grew 13% in Southwestern's southwestern Marcellus Shale fields, to just over 472 MMcf/d in the second quarter, while volumes from Arkansas' Fayetteville Shale, a field Southwestern pioneered, slipped 15% in the second quarter when compared to the year prior.