Can This High-Flying Natural Gas Stock Surge Higher in 2014?

Can This High-Flying Natural Gas Stock Surge Higher in 2014?

Cabot Oil & Gas had a phenomenal year in 2013, delivering a 54% year-over-year increase in production and a more than 220% jump in net income for the nine-month period ended Sept. 30. The markets liked what they saw, sending shares of Cabot surging by nearly 60% in 2013.

But with the stock sitting very close to its 52-week high, does Cabot have more room to run or is ripe for a pullback? Let's take a closer look.

The reasons behind Cabot's success
Despite the huge run-up in Cabot's stock price over the past 12 months, there are a couple of major reasons to continue to be optimistic about the company going forward. The first is its industry-leading growth in production and reserves and the second is its peer-leading low cost structure thanks to its large, high-quality acreage position in the Marcellus shale.

Over the period 2010-2013, Cabot grew its production at an impressive compounded annual growth rate of 45%, while reserve growth over the period 2009-2012 averaged 23%. The company boosted its reserves by 27% in 2012, bringing its total proved reserves to 3.8 Tcfe as of year-end 2012. Going forward, it expects to deliver 30%-50% production growth in 2014.

One of the biggest reasons behind the company's phenomenally successful drilling program is its highly attractive low cost structure in the Marcellus, where it commands roughly 200,000 net acres. Even with natural gas prices at $3.50, Cabot can generate a 115% internal rate of return, or IRR, on wells that cost it $6.5 million to drill and complete. One would be hard pressed to find another gas producer that can generate these kinds of returns.

Even Range Resources , another low-cost Marcellus operator with outstanding returns, requires $4 gas prices to generate a 96% IRR on its dry gas wells and a 105% IRR on its super-rich gas wells, while EQT earns a 53% after-tax internal rate of return on its Marcellus wells with gas prices at $4.

Furthermore, Cabot continues to improve the economics of its Marcellus drilling program through efficiencies that have resulted in steady year-over-year improvements in EURs, as well as IP and 30-day rates. During the third quarter, the company's unit costs fell 15% year over year and 4% sequentially to $2.97 per Mcfe, while cash costs declined 19% year over year and 8% sequentially to $1.25 per Mcfe, highlighting its progress in further improving its already peer-leading low cost structure.

What to expect from Cabot in 2014
Cabot's December operations update, which outlined results from its recently completed 10-well pad in the Marcellus, reaffirmed the strength of its Marcellus drilling program and suggests these positive trends should continue into the new year.

Not only did production rates from the 10-well pad exceed the company's 14 Bcf type curve, but results from its downspacing pilot program suggest that tighter downspacing should boost recoverable resource estimates across its Marcellus acreage. The company also reported substantial efficiency gains on the 10-well pad, slashing its drilling cost per foot by 30% compared to 2012 thanks to location cost savings, less move time between wells and other drilling efficiencies.

Another major reason to be bullish on Cabot going into 2014 is its recent execution of a long-term gas sale and purchase agreement with Pacific Summit Energy LLC, which provides the company with a firm long-term outlet for its Marcellus gas production. As part of the agreement, Cabot will sell 350,000 MMBtu per day of natural gas from the Marcellus for a period of 20 years beginning in 2017, when the Dominion Cove Point LNG liquefaction project is scheduled to go into service.

Next year, Cabot plans to boost its capital spending by about 35%, with a larger portion earmarked for its operations in the Marcellus. The company expects to allocate roughly 74% of its $1.375 billion-$1.475 billion 2014 capital budget toward the play, up from 65% in 2013, where it will be operating a seven-rig program.

The bottom line
Though shares of Cabot currently trade at around 16 times forward earnings, that valuation may be more than justified given the company's extraordinarily strong prospects for growth. Furthermore, with more than 3,000 identified drilling locations located in the sweet spot of the Marcellus shale, representing more than 25 years of inventory at the current pace of drilling, Cabot has plenty of room to ramp up production next year and in the years to come.

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Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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