With natural gas price trading at multi-year lows, it’s expected that companies like Southwestern Energy (NYSE:SWN) will feel the impact. Southwestern Energy stock has however been resilient in the last eight months. During this period, the stock has traded sideways, amidst volatility. I believe that Southwestern Energy has bottomed out and provides a good entry opportunity.
Natural gas (Henry Hub) is trading at $1.58 and prices are already depressed. The company’s stock moving sideways is possibly an indication of natural gas prices bottoming out. Further, U.S. Energy Information Administration expects natural gas prices to average $2.19 in fiscal 2020 and $2.60 in fiscal 2021.
If we look at the reason for this relatively bullish outlook, EIA expects production to decline in the Appalachian and Permian regions. This can help in balancing the demand-supply scenario on a relative basis.
Therefore, in all probability, natural gas will trend higher from oversold levels. And so will Southwestern Energy Stock.
Southwestern Energy Is Undervalued
Natural gas price trending higher in the second half of the year is a potential positive trigger for the stock. From a company specific perspective, the valuation based on proved reserves is a reason to be bullish.
At the end of FY2019, the company reported total proved reserves to 12.7 Tcfe. The after-tax PV-10 (present value of estimated future oil and gas revenues) for Southwestern Energy was $3.7 billion.
Furthermore, the company reported net debt of $2.2 billion for the same period. Adjusted for debt, the PV-10 for the company comes to $1.5 billion. Currently, Southwestern Energy stock trades at a market capitalization of $1.1 billion.
Therefore, based on the present value of estimated future oil and gas revenues, the company looks undervalued. As natural gas price trends higher towards the end of the year or in FY2021, the PV-10 should adjust on the upside.
At the same time, Southwestern Energy reported a 6.7% growth in proved reserves on a year-on-year basis. With a healthy reserve replacement ratio, the proved reserves are likely to increase during the year and this adds to the valuation upside.
Credit Metrics and Southwestern Energy Stock
I remain positive on Southwestern Energy even from a balance sheet and cash flow perspective. As of FY2019, the company reported a net-debt-to-EBITDA of 2.3. The leverage is low and provides the company financial flexibility for using the undrawn credit facility.
In addition, the company reported operating cash flow of $913 million for the last financial year. For the year, the company has guided for capital expenditure of $900 million. With oil and natural gas prices declining, it’s likely that capital investments will be scaled down.
I believe that capital expenditure will be in-line with operating cash flows. That will help Southwestern Energy in keeping the leverage in check.
Furthermore, the company’s total interest expense for FY2019 was $166 million with EBITDA at $973 million. This implies an EBITDA-interest-coverage-ratio of 5.9. Therefore, debt servicing is likely to be smooth.
Even if the EBITDA declines by 50% and interest expense remain the same, the company’s interest coverage ratio will be 2.9. The point I am making is that even in a stressed scenario, Southwestern Energy is unlikely to face debt servicing issues.
With a relatively strong credit profile, Southwestern Energy stock can trend higher as natural gas prices recover.
My Final Views on Southwestern Energy Stock
Southwestern Energy was targeting production growth of 9% for the current year. However, that seems unlikely as capital expenditure will be scaled down. It makes more sense to pursue financial prudence at this time than pushing for growth.
However, Southwestern Energy stock has been largely sideways for months and the negatives factors are discounted.
The company has also been working on cost reductions and that should help boost the EBITDA margin once natural gas price trends higher.
I want to add that the company currently has $1.8 billion available under the $2.0 billion revolving credit facility. This ensures that the company is fully financed for the next two years. Therefore, balance sheet and liquidity is not a concern.
Once natural gas price trends higher, Southwestern Energy can ramp-up investments and production growth. This will translate into higher cash flows and value creation.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
