Is Cabot Oil & Gas a Good Investment?

After a strong earnings announcement by Cabot Oil & Gas Corporation (NYSE:COG) the stock was up over 10%. We see the bullish activity by investors, and a bullish outlook from the company as a solid vote of confidence for the natural gas industry. The question is: which natural gas companies are the best investments?

Cabot’s 3Q earnings came in at $0.21, up from $0.17 for the same quarter last year. The $0.21 EPS beat consensus of $0.14. The company is up 25% year to date despite having lowered production outlook for 2013 to 35%-50%, from the previous guidance of 45%-55%.

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For the natural gas industry, the EIA expects natural gas consumption to be up 4.7% for 2012 from a year ago, with the key driver being the use of natural gas in the electric power sector. Depressed natural gas prices have convinced many power providers to switch from coal to natural gas. However, the driver for 2013 is expected to be a more normal winter and a return to colder temperatures.

Cabot is one of Dan Loeb’s top pick and was a new addition during 2Q for the firm. Other top name investors were Ken Griffin and Columbus Circle Investors. As well, fund managers Chuck Royce and D.E. Shaw gave votes of confidence to Cabot by upping their 1Q stakes 25% and 200% respectively. There have been, however, a few insider sales of late, in the range of $42.50-$43.50.

Cabot’s promising growth prospects allow the company to trade at a premium valuation, thanks namely to its top-tier production in the Marcellus Shale. Cabot is forecasted to boost capital expenditures to fund growth, with CapEx that is expected to come in at $775-$825 million for 2012, and be up to $900 million to $1 billion for 2013.

Cabot has some of the best growth prospects compared to top competitors EOG Resources, Inc. (NYSE:EOG), Williams Companies (NYSE:WMB), Williams Partners (NYSE:WPZ) and Southwestern Energy (NYSE:SWN).

EOG is a worldwide producer of natural gas, and has been making a shift toward unconventional liquids to have a more diversified portfolio. EOG, being the largest of the five natural gas companies by market cap, is seeing less production growth than some of the other gas plays. For 2012 as a whole, production is expected to be up 9%, compared to 9% growth in 2011. The company’s 2012 CapEx spending plan of $7.5 billion will be heavily invested in natural gas liquids and oil.

Williams Companies, a processor and transporter of natural gas, was one of the four pipeline stocks that hedge funds were buying at the end of 2Q. The company also has a strong presence in the Marcellus Shale. Williams Companies expects to post 2012 EPS that is down from 2011, from $1.23 to $1.15. However, 2013 EPS is expected to come in at $1.50. Beyond that, EPS growth will be driven by its $25 billion capital expenditure plan for 2012-2017.

Williams Partners is engaged in gathering and transporting natural gas, as well as storing natural gas liquids. The company calls Williams Companies its general partner. Yet, we see Williams Partners as a better natural gas play given its midstream focus. The company has much more exposure to the electric and power generation sector, which is where the overall demand increases for natural gas are coming from.

Southwestern operates in two key regions, and even with 2012 production growth of 13%, the company expects to see a sharp EPS decline, going from $1.82 in 2011 to $1.17 in 2012. The company expects to spend $4 billion on CapEx for 2012 in hopes of revamping cost structure and exploring new territories. Thus, if inventory buildup continues for the industry, Southwestern will be positioned well as it has more flexibility over production.

On a valuation basis, Cabot trades at 85x trailing earnings, but at a forward P/E of 40x. Cabot’s high P/E is a bit frightening from a valuation standpoint, and so we would be cautious when considering the company. Meanwhile, Williams Partners has the lowest P/E of the five companies and also pays the highest dividend yield, at 6%. We see Williams Partners as a top play on the industry, supported not only by its operations, but also by its valuation and solid dividend.

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