Cash Flow Is King

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XTO Energy (NYSE: XTO) employed an interesting rhetorical device during its third-quarter earnings call. At both the beginning and end of remarks, management declared that cash flow is king. This takes the cliche that "cash is king," and twists it in a way that puts XTO in the best possible light. Clever.

XTO is, indeed, a cash flow machine. Compared to last year, quarterly cash flow was up 66%. Per-share operating cash flow came in at $2.75, which beat the consensus Street estimate by roughly 20%. The cash bash is bound to continue, thanks to one of the most brimming hedge books in the industry.

I noted last year that XTO prefers hedging one-half to two-thirds of production in order to smooth out the commodity cycle. Well, the company has already locked in more than 70% of 2009 production at close to $11 per thousand cubic feet equivalent. The natural gas hedges are around $9, and the oil hedges really throw the afterburners on. Like its buddy in the Bakken shale play EOG Resources (NYSE: EOG), XTO's oil play is doing wonders for those "natural gas equivalent" metrics. With the continuing chasm in value between equal BTU quantities of oil and natural gas, it's clear that the two commodities are definitely not economically equivalent.

But I digress. Even with a roughly 15%-20% budget cut in the works for 2009, XTO is looking at more than 20% production growth and free cash flow generation of $1.5 billion to $2 billion. The budget cuts, I should mention, would be a combination of lower service costs and lower drilling activity. So there's certainly no sign of a broken business model here.

The only area where XTO is lacking in comparison to an EOG or an Apache (NYSE: APA) is in the balance sheet realm. Whereas EOG is breathing easy with 10% net debt to capitalization, and Apache's debt is a "manageable 20% or so," XTO's net debt rang in at more than 40% of total capitalization at quarter's end. This company's game plan is now all about the two Ds: drill bits and debt reduction. No more extensions to extol, such as the Linn Energy (Nasdaq: LINE) buy in the Marcellus or the Hunt Oil purchase in Chesapeake Energy's (NYSE: CHK) prized Haynesville playground.

It's a good thing XTO has done such a fine job hedging, or my confidence would be a bit shaken in this most capable hydrocarbon captain.