Houston-based energy producer Ultra Petroleum (NASDAQ:UPL)has been one of the best-performing energy stocks of 2014, with shares up more than 35% year to date. Much of the company's recent strength is likely due to higher natural gas prices and an upward revision of earnings growth prospects. The important question now is whether or Ultra's run is over, or can shares continue to surge?

Photo credit: Anadarko Petroleum.

Why Ultra still has upside
In a recent note, Raymond James articulated a compelling thesis as to why Ultra Petroleum shares should continue to march higher. The thesis is based on three key factors: 1) the expectation that Ultra's production growth will easily exceed the company's 5%-9% guidance for 2014 ,2) falling leverage, and 3) anticipation that tighter gas storage will pave the way for higher gas prices next year. Raymond James also sees short covering as a catalyst to drive Ultra's price higher and set a price target of $36 a share.

Possibility of stronger than expected oil production growth
Given Ultra's tremendous progress in the Uinta Basin and its history of conservative projections, I think Raymond James may be right that the company's guidance for 5%-9% production growth this year could be overly conservative, especially given Ultra's history of underpromising and overdelivering.

Initially, Ultra said it would enter 2014 with a run rate of 4,000 barrels of oil equivalent per day (BOE/D) in the Uinta. But its actual production going into the new year turned out to be more than 7,100 BOE/D. Ultra now expects to exit 2014 with a run rate of 11,000 gross barrels of oil per day in the Uinta, up from initial guidance of 8,000 BOE/D. Despite the upward revision, actual production could turn out to be even higher, judging by recent performance.

Though it has barely been three months since the Uinta transaction closed, Ultra is already drilling new wells at record speeds, with a recent well drilled to total depth in less than three days, thanks to efficiency improvements from its implementation of 24-hour frac operations. If the company can continue to improve at this rate, its oil production could more than triple from last year's levels, boosting EBITDA and cash flow by even more than the 40% the company is forecasting.

Falling leverage
Ultra's leverage also looks likely to improve, which should better its risk profile and boost investor confidence. Leverage concerns have weighed on the company's share price, as investors fretted about its heavy long-term debt of $2.5 billion and its comparatively trivial $10.8 million in cash and equivalents.

This situation resulted in a worryingly high debt-to-EBITDA ratio -- a crucial gauge of the company's ability of repay its debt and one that is frequently used by credit rating agencies to assess the probability of default. As of year-end 2013, Ultra's debt-to-EBITDA ratio stood at about 3.5, which was barely enough to comply with the covenant for its revolving credit facility that matures in October 2016.  

But with Ultra's EBITDA and cash flow forecast to grow 40% this year, its debt-to-EBITDA ratio should fall from 3.5 times as of year-end 2013 to well under 3 times by year-end 2014. Full-year 2014 EBITDA should total $845 million, while cash flow should come in at more than $700 million, which leaves roughly $140 million that can be used to pay down debt, assuming the company meets its target of a $560 million capital program.

Possibility of higher than expected gas prices
The third catalyst that could propel shares of Ultra even higher is an increase in natural-gas prices. While many analysts and traders believe that continued rapid growth in domestic gas output will keep prices range-bound, others believe that production growth could turn out to be weaker than expected, potentially leading to a shortfall in inventories and boosting prices.

Higher gas prices would propel the value of Ultra's reserves sharply higher. Based on a gas price of $3.50 per Mcf, the PV-10 value of Ultra's proved reserves -- defined as their pretax future net cash flow discounted at 10% -- was $4.1 billion as of year-end 2013. But assuming a gas price of $4.50 per Mcf and an increased investment scenario, the PV-10 value of Ultra's reserves would more than double to $8.5 billion. Considering that Ultra's enterprise value is currently just $7.5 billion, this suggests the company could be meaningfully undervalued.