Kaizen is a business philosophy, originating in Japan, that stresses success through small but continuous improvements. Companies that constantly improve operational efficiency without a lot of fanfare can achieve great results, while still passing under the radar of most investors.
One such company is Southwestern Energy (SWN 2.71%), the fourth largest natural gas producer in the lower 48 states. Southwestern focuses on the development of natural gas in the Fayetteville shale in Arkansas and the Marcellus shale in Pennsylvania, while exploring for oil and gas in other areas of North America.
The company is also involved in gathering and marketing natural gas. Its subsidiary, DeSoto Gathering Company, operates 1,852 miles of gathering lines in the Fayetteville Shale. DeSoto gathered approximately 2.3 billion cubic feet per day in 2012. Angelina Gathering Company, another Southwestern subsidiary, operates approximately 25 miles of pipe in the Marcellus shale.
The table below compares Southwestern with two larger gas producers, Chesapeake Energy (CHKA.Q) and Anadarko Petroleum (APC).
| Company | Market Cap ($B) | P/E | Net Margin (ttm) | Yield |
|---|---|---|---|---|
| Chesapeake Energy | 17.4 | 21 | 6% | 1.1% |
| Anadarko Petroleum | 55.0 | N/A | -15% | 1% |
| Southwestern Energy | 14.6 | 19 | 21% | N/A |
Continuous improvement
A couple of things stand out about Southwestern. Its net margins for the past year are way out in front of the larger companies, but its P/E ratio is not out of line. Concentrating on growth, Southwestern isn't for income investors, as it currently pays no dividend.
For the quarter ended March 31, 2014, revenues were 52% higher than those in the same quarter a year ago. Operating margins improved while net margins stayed steady, leading to a 52% increase in net earnings as well. Debt to equity is a manageable 122% and discretionary cash flow exceeded capital investments by $75 million, according to a company presentation.
Southwestern's record production of 182 billion cubic feet of natural gas in the quarter was up 23% because of strong results in the Fayetteville and Marcellus plays. The company projects a 2014 capital investment program of $2.3 billion, and for production to grow 14% during this year.
Source: Sourhwestern Energy.
The above slide goes a long way toward explaining how Southwestern achieves such results. Over the past several years, the company has continuously improved key operational metrics such as days to drill, cost per million cubic feet of gas produced, and overall well costs. All of this increases efficiency and profitability, of course, but such consistent improvements aren't a matter of random events, wishful thinking, or luck. They result from a conscious philosophy on the part of the company.
Southwestern doesn't try to reinvent itself through massive acquisitions, grab headlines every other week, or send out grandiose press releases on every new project development. Instead, it just quietly makes small operational improvements year after year with little fanfare. The company even boils down this strategy into a quasi-mathematical formula (scrawled in red on the slide of the above table), which translates into English as, "The right people doing the right things, wisely investing the cash flow from the underlying assets, will create value."
Should Fools rush in?
Companies that can turn a business philosophy into a clear strategy are often worth a look. Southwestern's earnings will come out on August 1, so we'll see if the history of success continues. While the company isn't for income investors, it's fine for both growth and value oriented buyers. The stock price has come off its peak considerably in the past couple of months, so the market may be giving us a bargain here.
