Cabot Oil & Gas (NYSE:COG) has delivered truly exceptional growth over the past few years, thanks largely to its highly attractive drilling program in Pennsylvania's Marcellus shale, the fastest-growing shale gas play in the country.
In the third quarter, the company's production surged 61% year over year, while net income nearly doubled, fueling a more than 40% rise in its share price. Can this staggering pace of growth continue?
Why Cabot has been so successful
Even as many of its gas-focused peers have scaled back capital investment and dry gas drilling over the past few years, Cabot has charged full steam ahead. Since 2010, the company's production has grown at an annual rate of approximately 45%, while reserves rose at a similarly impressive 23% compound annual growth rate from 2009 to 2012.
Cabot's stellar growth has been led primarily by its position in the Marcellus shale, where it commands 200,000 largely contiguous net acres in the play's sweet spot. Even with a Henry Hub natural gas price of $3.50 per MMBtu, Cabot's typical Marcellus well that costs $6 million to drill and complete generates a roughly 115% internal rate of return, or IRR.
That's truly incredible, even when compared to its closest peers. For instance, Range Resources (NYSE:RRC), another Marcellus-focused driller with an extremely low cost structure, requires a natural gas price of $4 per MMBtu to generate a 96% IRR on its dry gas wells and a 105% IRR on its super-rich gas wells.
Can blistering growth continue?
After reaching a major company milestone in December 2012 when its gross Marcellus production rose above the 1 billion cubic feet per day mark, Cabot impressed yet again last month when it reported that gross production surpassed 1.5 Bcf/d. As a result, the company raised its 2013 production growth estimate to 50%-55%, up from an initial guidance of 35%-50% growth, and is targeting 30%-50% year-over-year production growth this year.
To help achieve that goal, Cabot plans to allocate nearly three-quarters of its estimated 2014 capital budget of $1.375 billion-$1.475 billion toward its Marcellus drilling program, up from 65% last year. Having added a sixth rig in the Marcellus in August 2013, it expects to add another rig soon to support plans to drill 130 to 140 net Marcellus wells this year.
One possible setback to the company's growth plans over the next few years, however, is a potential delay of the completion date for Williams Partners' (NYSE:WPZ) Constitution Pipeline -- a roughly 124-mile line that will run from Susquehanna County, Pa., to the Iroquois Gas Transmission and Tennessee Gas Pipeline systems in Schoharie County, N.Y. -- beyond the originally anticipated in-service date of March 2015.
Cabot, which has committed to transport roughly 0.5 Bcf/d on the pipeline, doesn't view a potential delay as that big of a deal. In its December update, the company said that a delay won't materially impact its expected production growth in 2015 due to its "diversity of takeaway options and the ample amount of lead time" it has to review any schedule changes and change plans accordingly.
Even if the in-service date for the Constitution Pipeline is pushed back to much later in 2015, Cabot can still significantly increase its takeaway capacity thanks to major expansion projects along the three pipelines that transport the bulk of its current production -- Kinder Morgan's (NYSE: KMI) Tennessee Gas Pipeline 300 Line, the Williams Companies' (NYSE:WMB) Transco Gas Pipeline, and the Millennium Gas Pipeline -- as well as the addition of new lines, including the Iroquois Pipeline and the TransCanada (NYSE:TRP) pipeline via Iroquois.
More growth ahead
All told, I strongly believe that Cabot can continue on its blistering growth trajectory for a long time. The company estimates that it has roughly 3,000 remaining drilling locations, which implies more than 25 years of inventory at current drilling levels.
Cabot can probably sustain production of 3 Bcf/day -- which it will likely hit by the end of 2016 -- for at least a decade, if not much longer. With such an exceptional outlook for growth over the next several years, I believe the company's seemingly lofty valuation of 18 times forward earnings may be more than justified.