By any fundamental measure, Southwestern Energy (NYSE:SWN) looks ridiculously undervalued. Based on consensus 2019 EPS of $0.67, the Southwestern Energy stock price is just 3.3x earnings. Asset-based valuations, too, look favorable: Southwestern Energy trades at just 0.4x tangible book value.
Of course, the reason SWN stock looks so cheap is not that earnings or book value are growing. Rather, the price keeps dropping. Southwestern Energy stock touched a 15-year low last week. Even after a bounce driven by either short-covering, bottom-timers, or both, shares still have fallen 56% over the past year. They’ve lost nearly 95% of their value in the last five years.
Shareholders and traders might see next week’s earnings report as a chance for SWN stock to reverse that trend. That seems unlikely to happen. There is an interesting case for Southwestern Energy stock at these levels, as a high-risk play. But SWN stock hasn’t fallen because of earnings, and it’s not likely to rise because of them, either.
The Natural Gas Problem for Southwestern Energy Stock
The problem for SWN is reasonably simple: natural gas prices are plunging. Futures hit a 3-year low last month. Henry Hub spot prices are flirting with decade-long lows reached in early 2016.
And as a producer leveraged mostly to those natural gas prices, Southwestern Energy is going to feel the pressure. The stock is cheap looking at 2019 (and 2018) earnings, but that’s not what drives the valuation of a stock. It’s forward-looking performance that matters, and right now the market sees pressure continuing for some time to come.
Indeed, the declines of late aren’t confined to SWN. Antero Resources (NYSE:AR) has performed even more poorly over the past year. Range Resources (NYSE:RRC) has been worse over the past three. Larger gas-heavy plays like QEP Resources (NYSE:QEP) and EQT Corporation (NYSE:EQT) have declined sharply as well, showing that even greater scale can’t offset lower prices.
To be sure, those companies haven’t helped their cause, either. Shale players in the U.S., until recently, focused on drilling over profits. As former EQT CEO Steve Schlotterbeck argued last month, the fracking revolution has “been an unmitigated disaster for any buy-and-hold investor in the shale gas industry with very few limited exceptions.”
Like gold miners, producers theoretically should have the leverage to affect underlying commodity prices. Like gold miners, the effect in practice has been even worse.
The Earnings Problem for SWN Stock
One quarter simply isn’t going to fix that problem for Southwestern Energy. There’s a clear lack of trust toward the space. Investors have fled shale gas plays in recent months: SWN has declined by more than half just since mid-April.
And even an earnings beat relative to the consensus EPS estimate of $0.10 is unlikely to fix that. Again, earnings are backward-looking; stock prices are forward-looking. Investors see more pressure ahead.
Most notably, the natural gas currently being “flared” likely will join the supply once pipeline capacity is put into place. That could force shale gas plays to either pull back on production or face even lower prices.
Investors expecting too much from earnings should look at Southwestern Energy’s recent history. The stock in fact has beaten consensus EPS expectations in five of the last six quarters. It’s obviously done nothing to stop the decline in Southwestern Energy stock.
The Case for Timing the Bottom
Even if earnings are unlikely to be the catalyst, there is a case for SWN stock in the low $2 range. Any optimism toward natural gas can lead to a rally; indeed, modest gains in the commodity led to a nice rally in the past few sessions.
After the company’s sale of its acreage in the Fayetteville Shale, the balance sheet is in reasonably good shape. The declines aren’t necessarily over, but traders and more aggressive investors could bet on a bounce here.
I’m not ready to take that bet quite yet, though. We’ve seen with stocks like Chesapeake Energy (NYSE:CHK) that even “cheap” energy stocks can fall further. Natural gas supply pressure seems unlikely to abate. It might seem like the worst is over for Southwestern Energy, but that’s likely not the case.
As of this writing, Vince Martin has no positions in any securities mentioned.
