Shifting Strategies In Natural Gas, A Path To Enhanced Profitability And Shareholder Value

Key Takeaways

• Coterra Energy's strategic focus on high-return areas and cost-effective production boosts operational efficiency and potentially enhances net margins.
  
• The company's strong fiscal strategy, including significant free cash flow towards dividends and share repurchases, aims to improve earnings per share and benefit shareholders.
  
• Coterra Energy's strategy amidst low natural gas prices risks short-term revenue but relies on market recovery and M&A for future growth and margins.

Catalysts

An independent oil and gas company, engages in the development, exploration, and production of oil, natural gas, and natural gas liquids in the United States.

• Coterra Energy's balanced revenue stream and geographic and geologic diversity provide market flexibility, allowing it to pivot between major U.S. basins as market conditions warrant, affecting revenue stability and growth.
  
• The company's ability to rapidly adjust production in response to natural gas market oversupply, including curtailing production and delaying drilling and completion activities without materially impacting cash flow, positions it to navigate near-term market volatility effectively, potentially enhancing long-term profitability.
  
• Coterra's drilling and completion strategies, focusing on disciplined capital allocation to its most profitable programs rather than production goals, foster operational efficiency and cost savings, which could boost net margins by optimizing capital expenditures.
  
• The incremental capital allocation towards the liquids-rich Permian and Anadarko basins, with a reduction in Marcellus spending, reflects a strategic shift to higher-margin opportunities, likely improving overall earnings through a more favorable production mix.
  
• Coterra's commitment to shareholder returns, underpinned by a strong free cash flow allocation towards dividends and share repurchase programs, supports the enhancement of per-share value through the market cycles, directly benefiting earnings per share and shareholder equity.

Assumptions

• Analysts are assuming Coterra Energy's revenue will grow by 11.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 23.5% today to 29.6% in 3 years time.
• Analysts expect earnings to reach $2.3 billion (and earnings per share of $3.43) by about August 2027, up from $1.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $2.8 billion in earnings, and the most bearish expecting $2.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 12.5x on those 2027 earnings, down from 13.2x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.0x.
• Analysts expect the number of shares outstanding to decline by 2.4% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.27%, as per the Simply Wall St company report.

Risks

• Coterra Energy's decision to curtail production in response to low natural gas prices could lead to reduced revenue and cash flow in the short term.
  
• The potential deferral of drilling and completion investments as a tactical response to oversupplied natural gas markets might impact the company's growth and future production volumes.
  
• Dependent on natural gas market recovery, the strategic curtailments and delayed activities could delay revenue growth and margin expansion.
  
• The reliance on a rebound in natural gas prices to enhance profitability introduces uncertainty and risk to earnings projections.
  
• The company’s exploration of M&A opportunities comes with the risk of overpaying or failing to achieve expected synergies, which could negatively impact net margins and earnings.

Valuation

• The analysts have a consensus price target of $33.44 for Coterra Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $41.0, and the most bearish reporting a price target of just $29.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.6 billion, earnings will come to $2.3 billion, and it would be trading on a PE ratio of 12.5x, assuming you use a discount rate of 7.3%.
  
• Given the current share price of $23.43, the analyst's price target of $33.44 is 29.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.