Range Resources Corp (RRC 3.25%) is one of the largest drillers in some of the hottest shale gas formations in America, including the hyper-prolific Utica and Marcellus.
Source: Range Resources Aug 18 Investor Presentation
In my last two articles, I explained why long-term investors should ignore the company's 10% earnings miss, and why the current valuation is justified, despite Range Resources having higher valuation metrics than competitors such as Rex Energy (NASDAQ: REXX), EQT Corporation (EQT 3.82%), and Southwestern Energy (SWN 2.71%).
In this article I'd like to examine the company's most recent conference call, an often underutilized resource that can give a greater understanding of how a company is doing and yield insight into its long-term vision.
Corporate goal is clear
"The Range story is simple, to create value on a per-share basis by driving up production and reserves at low-cost. We have a long track record of doing just that, focusing on per-share value creation." --President and CEO Jeffrey Ventura
The reason that looking at earnings on a diluted, per share basis is important is that often companies in highly capital intensive industries such as oil and gas production will dilute existing shareholders to fund growth.
RRC Total Return Price data by YCharts
As the chart above shows, fast growing Rex Energy has managed to outperform the market over the past six years, however its 9.88% annual dilution rate, compared to 2.06% for Range Resources, is very likely the reason that Rex Energy has failed to outperform its larger and slower growing competitor. Which brings me to my next quote, which shows Range Resources still has a long growth runway ahead of it.
Ambitious growth plans
"Looking ahead, we believe that we have the wells identified, the compression and plants planned for, and the takeaway capacity lined up to profitably grow our production to greater than 3 Bcfe per day. The plan is further de-risked given that assuming current strip pricing and differentials, we project that we can be cash flow positive in 2016 and that our planned growth beyond that can be within cash flow." --Jeffrey Ventura
The importance of this quote is that it emphasizes the fact that Range Resources has a well thought out plan to nearly triple capacity in the next five years.
Source: Range Resources Aug 18 Investor Presentation
However, equally important is how the company plans to finance its growth. If a gas company is growing quickly, sometimes its capital expenditures can grow faster than cash flows. That means the company has to take on additional debt, or dilute shareholders to keep growing, both tactics that can threaten long-term returns, especially with long-term interest rates expected to start rising soon.
Currently Range Resources is projecting 2014 capital expenditures of $1.52 billion and has $1.1 billion in liquidity available under its $2 billion borrowing capacity. With operating cash flows of $905 million, Range Resources shouldn't face any difficulty financing its growth plans, and with no debt coming due until 2016 (when cash flows are expected to cover growth spending), long-term investors can feel better about the company's balance sheet security. This is especially true given the fact that the company has been actively paying down its debt, with a current debt/EBITDA (earnings before interest, taxes, depreciation, and amortization) of 2.4, down 18% since Q1 and comparing very favorably to the industry average of 4.03.
Long-term growth rate to remain high
"We project that we will continue to grow 20% to 25% in 2016 and beyond, and gas demand is projected to grow significantly from LNG exports, petrochemical, power generation, manufacturing and transportation growth." --Jeffrey Ventura
This quote confirms what Kinder Morgan Inc has been saying for several quarters, regarding increasing demand for natural gas. With America's gas production growing so quickly it's vitally important that demand grow as well lest the price of natural gas collapse, wiping out the profitability of companies such as Range Resources and greatly hurting its long-term investment thesis.
Source: Kinder Morgan June 12, 2014 Investor Presentation
As the above table shows, not only is gas demand expected to rise 36% over the next decade, but the Marcellus and Utica shale, where Range Resources owns over 1 million net acres of land, is expected to increase its production by 112% over the same time period.
However, in order for the company to prosper Range Resources will need to be able to control its costs, preferably leveraging economies of scale to decrease its per unit production costs. As my next quote illustrates, management is firmly committed to this goal.
Long-term costs are declining
"We continue to improve our drilling and completion technology, including drilling longer laterals with more frac stages, our capital efficiency continues to improve...unit costs are expected to continue to decline as we build scale and spread our already low cost across a larger production base." --Jeffrey Ventura
Source: Range Resources Aug 18 Investor Presentation
As seen in this table, Range Resources' total production cost has declined at a compound annual rate of 7.66% over the last six years, and management is confident that the long-term trend of cost reduction will continue. This will help the company's operating and net margins, which should fuel strong earnings growth over the coming years.
Management is diversifying its midstream capacity
"We currently move our gas on 11 different interstate pipelines into 21 different indices. Range has the most diverse portfolio of interstate pipeline firm transportation arrangements with some of the lowest cost per MCF direct-to-markets with strong demand. We have recently announced new long-term transportation of sales agreements that are aligned with our growth." --Jeffrey Ventura
This final quote is important because Range Resources' recent earnings miss was a result of both expected and unexpected disruptions in both pipelines and processing centers owned by the company's midstream partners MarkWest and Sunoco. By diversifying its midstream suppliers Range Resources can better assure consistent operating cash flows, which as explained earlier, will let the company continue to grow at 20%-25% annually while simultaneously strengthening the balance sheet.
Takeaway
A company's earnings conference call transcript is often a great place to learn more about one's investments, both on an operational level and to get a better sense for a company's long-term vision and growth plans. The above quotes illustrate why Range Resources has been such a successful long-term investment and why that trend is likely to continue.
