Given the recent surge in natural gas prices, investors are becoming more interested in natural gas exploration and production companies. Two worth considering are Ultra Petroleum (NASDAQ:UPL) and Southwestern Energy (NYSE:SWN), which are predominantly natural gas producers that have recently made bold moves into liquids-rich plays.
While both companies are highly capable, low-cost operators, I think Ultra Petroleum's stronger prospects for production and earnings and cash flow growth, along with its more attractive valuation, make it the clear winner.
Ultra Petroleum's core assets are located in Pennsylvania's Marcellus shale, Wyoming's Jonah and Pinedale fields, and Utah's Uinta Basin. The first two are gas-rich properties, while the Uinta is a recently acquired oil-rich asset.
Meanwhile, Southwestern's core assets are located primarily in Louisiana's gas-rich Haynesville shale and the Marcellus. The company recently agreed to acquire liquids-rich acreage in Colorado's Niobrara shale and also has exploratory liquids prospects in Canada and the southern U.S.
Ultra has had a rough time in recent years due to the prolonged slump in natural gas prices, which forced it to slash spending from $1.5 billion in 2011, to $835 million in 2012, and to just $385 million in 2013. As one would expect, production, EBITDA, margins, and cash flow all took a hit. But 2014 should mark a new beginning for the company as it returns to profitable growth.
Ultra is boosting spending this year to $560 million and ramping up activity at its two most profitable operations -- the Jonah and Pinedale fields and the Uinta Basin -- which generate rates of return in excess of 70% and 500%, respectively. Given the exceptional economics of these assets, the company forecasts 40% year-over-year growth in both EBITDA and cash flow.
Meanwhile, Southwestern is targeting a 2014 capital investment program of $2.3 billion, up modestly from $2.25 billion last year. Growth will come primarily from the company's Marcellus operations, where production is expected to grow by 60% year over year, while Fayetteville volumes are expected to be essentially flat.
Southwestern is guiding for full-year 2014 net income of $635 million to $645 million and operating cash flow of $1.92 billion to $1.93 billion, which is lower than last year's net income of $703.9 million and operating cash flow of $2 billion. However, the company could easily exceed these targets since its guidance assumes a 2014 NYMEX gas price of $3.75 per MMBtu, compared to the roughly $4.50 per MMBtu price the futures market is implying.
Now for the most important part -- valuation, arguably the best predictor of a stock's future returns. In this respect, I think Ultra is the undisputed winner. It trades at just under 8 times forward earnings, compared to just under 17 times for Southwestern. Ultra also looks meaningfully undervalued when you consider the value of its assets relative to its enterprise value.
Under an increased investment scenario assuming a $4.50 per MMBtu wellhead gas price, the PV-10 value of Ultra's proved reserves -- defined as their pretax future net cash flow discounted at 10% -- is $8.5 billion, significantly higher than its enterprise value of roughly $6.2 billion. With the futures markets predicting a gas price of roughly $4.50 per MMBtu over the remainder of the year, I think $8.5 billion is a better estimate of the company's value and suggests a fair value for the stock of $35-$40 a share.
However, Southwestern's property in the Niobrara shale, which it agreed to purchase for about $180 million in March from Quicksilver Resources (NASDAQOTH:KWKAQ) and a Royal Dutch Shell (NYSE:RDS-A) subsidiary, could be a game changer for the company due to the higher margins and cash flow from liquids production.
As Southwestern plans to begin drilling in the Niobrara as early as June, investors should keep an eye out for details regarding resource potential, development costs, rates of return, and other material information. These could have a meaningful impact on the company's net asset value and share price.
As you can see, Ultra's EBITDA and cash flow growth prospects are much stronger than Southwestern's due largely to an expected tripling of its oil production this year. Combined with its much more attractive valuation, I think Ultra is almost certainly the better investment right now. That said, Southwestern's newly acquired assets in the Niobrara offer significant upside potential to production, reserves, margins, and cash flow that could be a catalyst to boost its share price.