In recent articles I've explained why Range Resources Corp (RRC 3.25%), the largest gas producer in the hyper-prolific Marcellus shale, might still be a good long-term buy despite its historically high valuation. In another article I introduced investors to the quarterly conference call, explaining how it can be an invaluable resource for gaining insight into the company's long-term vision. Well, as it often does, Mr. Market seems to have disagreed with me, at least in the short term.
Recently, Range Resources and its Marcellus-based competitors, Rice Energy (NYSE: RICE), Rex Energy (NASDAQ: REXX), Southwestern Energy (SWN 2.71%), EQT Corporation (EQT 3.82%), and EQT Midstream Partners (EQM), have been handed a thorough shellacking by Wall Street, declining between 11% and 51% from highs set in June.
Rex Energy in particular has taken a beating (down 51%), one not justified by the company's fundamentals. For example, the company recently released an operational update in which it raised third quarter production expectations above its recent high end guidance, increased its borrowing base by 36%, and announced an acquisition of additional acreage in the Appalachian Basin. In addition, the company, like Range Resources and its competitors, has been successfully lowering drilling costs, down 15.4% in the last year in Rex's case, due to closer well spacing (which the company uses as part of its "Super Frack" technology).
Finally, back in August, Rex Energy set the stage for continued growth when it reached a major deal with the largest midstream operator in the Marcellus, MarkWest Energy Partners LP (NYSE: MWE), to provide it with 405 million cubic feet/day of processing capacity at its Bluestone III and IV facilities, set to go online in Q4 2015 and Q2 2016, respectively.
Why the price drop?
The steep price decline is most likely a result of two things that have plagued Range Resources and its competitors: generous valuations and a short-term decline in natural gas prices of 13.4%.
However, as this article will now explain, Range Resources, Rex Energy, and their competitors now offer an intriguing long-term buying opportunity due to strong earnings growth prospects.
| Company/MLP | Yield | 5 Year Projected Earnings Growth | 5 Year Projected Dividend Growth |
| Range Resources | 0.20% | 28.35% | 14.87% |
| Rice Energy | 0% | 92.83% | na |
| Rex Energy | 0% | 52.50% | na |
| Southwestern Energy | 0%% | 17.10% | na |
| EQT Corporation | 0.10% | 25.13% | 16.72% |
| EQT Midstream Partners | 2.40% | 20.63% | 23.65% |
| S&P 500 | 1.89% | 12.54% | 5.05% |
There are three key reasons to believe that these earnings (and dividend/distribution growth) projections can be reached, which would greatly increase the chance of long-term investors being rewarded with many years of market-beating total returns.
Long-term demand trend for natural gas is highly positive
According to the Energy Information Administration, U.S. natural gas production is expected to increase 50% between now and 2040. The demand growth is expected to come from US power plants switching to cleaner gas, liquefied natural gas exports, and increased use of natural gas to fuel vehicles.
Source: EIA 2014 Energy Outlook Report, MT-16
This increasing demand is expected to result in a rising natural gas prices, which is what will make possible the second trend likely to fuel Range Resources' growth.
Source: EIA 2014 Energy Outlook Report, MT-22
Marcellus and Utica shale production set to explode
The Marcellus and Utica shale (where companies such as Rex Energy and Range Resources operate) have been the dominant reason that U.S. gas production has increased so remarkably in recent years. For example, between 2007 and 2012 the Marcellus and Utica shale saw production soar 15-fold and 10-fold, respectively. In addition, according to Kinder Morgan Inc, America's largest gas pipeline operator, production from these shale formations is set to grow 112% over the next ten years.
Range Resources plans to take advantage of this by nearly tripling its production by 2018.
Source: Range Resources Aug 18 Investor Presentation
According to President and CEO Jeffrey Ventura, not only is management diversifying its midstream suppliers, which decreases the chances of future earnings misses, but it's working toward making production growth self-sustaining by decreasing production costs and increasing operating cash flows to the point that growth can be financed without debt. That would protect Range Resources from another credit crunch, as occurred in 2008-2009, and is a major competitive advantage Range has over its rivals, whose average debt/EBITDA ratios stand at 4.03 compared to Range Resources' 2.4.
Falling drilling costs
Source: Range Resources Aug 18 Investor Presentation
Range Resources has a very good track record of decreasing its unit production costs by 7.66% annually over the last six years. The key is more advanced fracking techniques such as downspacing and drilling longer laterals.
Rex Energy has also had much success with these techniques, which it dubs "super fracking," and its wells have seen a 75% increase in EUR (estimated ultimate recovery) in exchange for a 38% increased drilling cost.
Decreased unit production costs lead to stronger profit margins, which when combined with soaring production growth, and a positive projected long-term trend in natural gas prices, mean likely strong earnings growth like that forecast by analysts over the next five years.
Bottom line
Range Resources and its competitors offer long-term investors an excellent way to profit from America's historic natural gas boom, even more so now that their share prices have declined by so much. Fueled by the above three trends, I believe these companies have an excellent chance of outsize total returns over the next five to ten years.
