(By
Mark Hanson, CFA) Ongoing
U.S. oversupply combined with mild winter weather has weighed heavily
on U.S. natural gas prices over the past few months. Nymex Henry Hub is
currently at $2.50 per thousand cubic feet, 50% below this time last
year, with gas prices down 30% since November alone. Not surprisingly,
the stock prices of dry gas producers such as Ultra Petroleum (
UPL), Range Resources (
RRC), and Chesapeake Energy (
CHK) are all down 20% or more in the past few months.
Uncertainty about the extent of oversupply over the next few years is
adding to the current bearish sentiment on natural gas. Unknowns
include exploration and production efficiency (getting more production
from less investment), gas associated with liquids production, well
inventory waiting on completion, weather (always a wild card), and the
potential uptick in demand to absorb excess supply. Oversupply may end
up being less bad than the futures market predicts over the next several
quarters, thanks to marginal gas producers pulling back on drilling
activity (in part because of hedge books that have rolled off) and
E&Ps achieving held-by-production status in regions like the
Haynesville.
While there's no question current natural gas prices are below most
everyone's expectations, we think the market is assuming unreasonably
low long-term gas prices. By our math, Ultra's current stock price
assumes gas prices of $4.00-$4.25 per mcf in perpetuity. The Nymex Henry
Hub futures curve hits $4.50 beginning in mid-2014 and only increases
from there, however, which would imply much more bullish expectations
about the long-term picture for natural gas.
We arrive at our $60 fair value estimate for Ultra primarily through a
five-year discounted cash flow analysis, supplemented by an assessment
of longer-term resource potential, trading multiples, and comparable
transactions. Near-term gas price weakness represents a challenge, but
Ultra's balance sheet, hedge book, and low maintenance capital
expenditure requirements should help the company get through the next
several quarters relatively unscathed. We think Ultra's current trading
price represents a reasonable entry point for longer-term investors,
with a handful of near-term catalysts that could lead the market to
revalue the stock this year.
Ultra is a small, independent E&P that holds some of the best
assets in North America in the Pinedale Field of Wyoming and Marcellus
Shale of Pennsylvania.