Antero Resources Is A Buy Due To Passing The Crash Test

seekingalpha04-09

After underperforming alongside natural gas prices, the share price of Antero Resources has begun to outperform that of other producers, driven by a positive outlook for 2024 and beyond.AR has ...

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Fentino Introduction Common sense tells us that with natural gas prices recently hitting multiyear lows, it's a challenging time for natural gas producers, especially for unhedged ones like Antero Resources (NYSE:AR). However, it seems there are alternative survival strategies in the low-price environment beyond hedging, and AR has effectively utilized them. Both AR's financials and recent share price movements indicate a successful passage through the current market challenges, suggesting that AR remains a buy, with a promising future outlook once natural gas prices reverse. AR share price: down and up again In my first AR article in November of last year, I rated it as a buy due to its superior transportation capabilities, NGL exposure, and unhedged strategy in the natural gas market. Additionally, I suggested that their share price underperformance compared to peers observed since the second half of 2022 would revert. In the meantime, some of these ideas received supporting evidence. Besides, AR has released its 2023 earnings and 2024 guidance, both of which were positively received by the market. Let us delve into the recent changes for AR. Although AR's share price is almost the same now as it was on the day of my last article in mid-November, it has experienced significant fluctuations. Between these two dates, it underwent a noticeable dip alongside natural gas futures, attributed to the warm winter and preceding growth in natural gas production. While I don't consider the warm winter itself a long-term bearish factor and have previously highlighted it as a buying opportunity rather than a risk, the abrupt 3-4 Bcf/d production growth in November 2023 was quite unexpected and therefore raised concerns. As articulated by AR during their earning call last month: …we had slides out there thinking that after the 9 to 12 months kind of time period from when the rigs really started to drop last May, you'd start to see a response in production that's historically kind of the time frame that's required to work through that high rig count level. You haven't seen that yet. You actually saw the opposite. So that has been surprising to us. Company Presentation from https://www.anteroresources.com/investors/presentations This growth in production appears to be a result of pipeline expansions in the Permian, where associated gas is abundant, coinciding with seasonal production growth in Appalachia. However, since then, production has fallen back due to producers' reactions to low natural gas prices. In its recently updated company presentation, AR is projecting a significant 4.8 Bcf/d shortage of natural gas demand in 2025, assuming flat power burn and maxed-out Permian pipelines. By the end of 2023, and more prominently in 2024, AR's share price stopped underperforming that of other producers protected from the low-price environment via hedges—a trend observed since the second half of 2022, as highlighted in my previous article. Image created by author with historical data from https://finance.yahoo.com/ Why was this trend broken? On February 14th, AR released its earnings for Q4 2023, showing a decent 90 million USD in FCF. Positive FCF in what is perceived as a low-price environment is attributed to the significant production of NGL. However, the most promising news came with the reduction in CapEx outlined in the 2024 guidance. While AR announced a decrease in production costs last summer, this time the extent of the reduction was staggering: Antero's 2024 drilling and completion capital budget is $650 to $700 million. Net production is expected to average between 3.3 and 3.4 Bcfe/d during 2024. Efficiency gains, a lower base decline rate and an average lateral length increase of 2,000 feet per well allows for a maintenance capital program with 26% lower capital than the prior year. Evidently, reducing CapEx by 26 percent while keeping production flat makes it easier to survive in a low-price environment. To hedge or not to hedge While AR was projected to produce positive FCF in 2024, some natural gas producers with extensive hedging programs were estimated to be less profitable this year. For example, EQT Corporation (EQT) and Comstock Resources (CRK) were estimated to produce negative FCF here and here. As an engineer, I perceive hedging, on average and roughly, as a low-pass filter: it mitigates the influence of transient rips and dips for the company, selling their natural gas at a fixed all-time average price. However, a company without hedges will ultimately receive as much money as if they were to sell all their natural gas at an all-time average price. Nevertheless, their journey would be bumpier, with all the rips and dips, and the possibility of bankruptcy if the dip is too low and too long. Even if natural gas prices reach an all-time high after bankruptcy, it does not benefit the unfortunate investor. With hedging, it would be easier for any company to survive in such a situation. Additionally, the abovementioned long-term price equivalence between hedged and unhedged producers holds only if statistical properties of the price do not change over time. In a market with rising prices and increasingly higher dips and rips, hedging would be detrimental, whereas in an ever-falling market with deeper dips and lower rips, it would be advantageous. Thus, Antero's application of an unhedged strategy could indicate, among other things, that in their view, natural gas prices are currently lower than they will be in the future. The elevated exposure to higher NG prices due to remaining unhedged is an important part of my investment thesis from the previous article. Recently, such exposure was mentioned by J.P. Morgan as a reason for upgrading AR shares from neutral to overweight. Anyway, if a company finds a way to mitigate the downturns while remaining fully exposed to the upcoming upswings, the need for hedges is eliminated. At least for now, AR appears to be this type of company. How did they achieve this? Let's take a closer look. The grapes of wisdom Back in 2014, AR produced an average of 0.869 Bcf/d of natural gas and roughly 23 MBbl/d of liquids. Since then, the company has grown, producing 2.2 Bcf/d of natural gas in 2023, a 153% increase. What is interesting is that liquid production has grown much faster, reaching 193 MBbl/d in 2023, a 753% increase. According to recent estimates, liquids will contribute 41% of AR's revenue in 2024. Thus, the ability to survive low natural gas prices, in part, stems from the strategic decision made by AR management years ago to develop the NGL part of their business. The same holds for their transportation capabilities, which typically allow AR to sell their natural gas at a premium to Henry Hub. Like with increasing NGL production, this advantage is a result of long-term strategic decisions. The premium grows, and thus, the advantage becomes most obvious during extreme weather conditions. I have estimated in my previous article that AR earns at least several dozens of millions extra per strong winter storm due to their ability to sell natural gas where it is most needed, and I expect the same from winter storm this January. This would not be the case if AR's natural gas production were hedged, making the decision to remain unhedged more prudent for AR than it would be for other natural gas producers. Valuation AR's financials are heavily reliant on natural gas prices. Due to its volatility, natural gas is often referred to as the \"widowmaker\". Therefore, when considering investment in AR, one should keep in mind various scenarios. Let's consider some of them. As observed this year, in the low-price environment, AR is projected to maintain a slightly positive cash flow. To understand potential yields in higher price scenarios, it's useful to examine their 2022 figures first. In 2022, AR earned almost 2 billion USD in FCF. Throughout the year, AR's realized natural gas price peaked at 6.9 USD/Mcf before hedges, yet post-hedges, the actual sale price settled at only 4.54 USD/Mcf. Currently, natural gas futures for 2026 and 2027 average at 3.82 USD/Mcf. However, after considering production growth in 2023 and the addition of over 200 million USD in CapEx reductions to FCF, a 2 billion USD FCF estimate remains valid for AR at the current strip. This represents a 20-25% FCF yield, providing AR with comfort regarding their 1.5 billion USD debt. Thus, like the share price, the valuation of AR did not change much from the last paper. Weaker natural gas futures prices are compensated by a decrease in production costs and higher NGL exposure. The volatility of NG prices works both ways, with the potential for prices to exceed current future curve projections. Regarding higher NG prices, it's worth noting that with a projected 2024 production of 2.1 Bcf/d, AR's FCF increases by 1 billion USD for each annual NG price increase of 1.3 USD/Mcf. Risks In part, AR's ability to earn money during low natural gas prices is probabilistic in nature, in a sense that it is less certain than for companies with hedged production. Even with eggs in several baskets, there's no guarantee of complete safety. While AR earns significant profits during winter storms, what if none occur in the coming years? They also sell a substantial amount of NGL, but what if the NGL market experiences a downturn like the natural gas market did recently? These risks are tangible. It's understandable that the probabilistic nature of AR strategy makes many investors uneasy, leading them to avoid investing in AR and similar companies. Personally, I don't find this discomforting, as there are also probabilities for severe winter storms, colder winters, and further growth in NGL prices. A glance at the long-term graph of natural gas futures reveals that certain risks materialize frequently. Whether it's a technological breakthrough that could reduce NG production costs in the typically expensive Haynesville region, a real LNG ban, or a sudden surge in associated gas production accompanied by an increase in takeaway pipeline capacity—there's always a plethora of doomsday scenarios in any investment domain. I recommend that every investor keep a close watch on long-term factors that influence the supply-demand balance. Conclusion  There are strong signals that AR is weathering the low natural gas price environment better than expected for an unhedged producer. Simultaneously, being unhedged makes them very attractive for times when natural gas prices rise. Thus, they can both comfortably wait till the natural gas prices increase and get maximum profits when it happens. Therefore, AR remains a buy.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2426199119"}