Is QEP Resources a Good Natural-Gas Play?

Natural-gas producer QEP Resources (NYSE: QEP) seems to be another player that could benefit from the expected boom in its niche over the next few years. But is the company financially well placed enough to take advantage of the situation?

The fundamentals
Earnings before interest, taxes, depreciation, and amortization -- a metric that reflects returns from core operations -- have significantly improved over the years. This is where I like to begin assessing a company's ability to operate efficiently and effectively on a day-to-day basis.

The company's EBITDA compound annual growth rate over the past five years stands at 13.3%. That looks decent next to some peers with similar market caps: Cabot Oil & Gas (NYSE: COG) has a corresponding value of 3.1%, Ultra Petroleum (NYSE: UPL) is at 12.6%, and Denbury Resources (NYSE: DNR) stands at 18.1%.

Production and year-end reserves have increased substantially over the last few years as well, indicating that the company's core business in exploration and production has grown substantially and that there's a solid future to look forward to. Production at the end of 2010 stood at 229 billion cubic feet equivalent (Bcfe) -- a 21% increase from 2009.

A few concerns
At the same time, revenues over the past few years have stalled. And profit margins have taken a hit because of lower natural-gas prices, despite increased production. I'm not overly worried, though, as macroeconomic conditions should help QEP turn things around on this front shortly.

Gazing into the future, I note that QEP's expansion plans appear to be solid. As a result of increased drilling activity in 2010, capital expenditures have shot up in excess of $1.5 billion for the third time in the past four years.

What's more, the company’s midstream services arm expanded capacity in its processing and treating facilities in Wyoming, Utah, and Louisiana. A capex budget of $1.2 billion forecasted for 2011, of which 40% is earmarked for oil and liquids-rich natural-gas projects, is an indication of QEP's aggressive growth plans.

This all sounds good, but the negative free cash flow of $465 million does not. The company plans to fund its capital expenditures with cash flow from operations and borrowings under its revolving credit facilities. With total debt of more than $1.5 billion, QEP is playing a pretty aggressive game here. A quarter or two of bad luck could seriously imperil investors.

Another troubling issue is increasing operational inefficiency. ROE has, in fact, dwindled to 9.1% from double-digit values, which were the norm only a few years back. Much of the decline is down to market pressures, I'm sure, but when it comes to generating a decent return on your investment, the reason is pretty much irrelevant.

How cheap is the stock?
Here's how QEP Resources stacks up compared to its peers.

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

The trailing price-to-earnings figure indicates that QEP is undervalued against an industry average that stands at 32.2. The company looks inexpensive in terms of core operational earnings as well.

Price-to-book value has gradually gone up in the past three quarters and now stands at 2.4. The overall market seems to be revaluing this company's book over time. Still, when benchmarked against what analysts are expecting in terms of growth, QEP isn't the most compelling buy in the group. .

Foolish bottom line
Although a boost in natural-gas demand will definitely boost earnings, it's hard to predict how much benefit QEP will generate from favorable market conditions. If you think the company has substantial growth prospects, then you could dig deeper to get a clearer picture. Otherwise, I'd pass.