On Jun 26, 2013, we retained our Neutral recommendation on natural gas producer Ultra Petroleum Corp. (UPL). Our investment thesis is supported by a Zacks Rank #3 (Hold).
Why the Reiteration?
Taking a cautious view of gas prices, Ultra Petroleum has focused its capital program on the promising liquids-rich plays, which is a major shift away from dry natural gas development. The company has trimmed its current year capex by 50% from last year’s level, while still looking for robust production.
While subscribing to management’s outlook, we believe the realignment of Ultra Petroleum’s portfolio will take some time to bear results. The company also lacks geographic diversification, which somewhat hampers its competitive positioning.
Detailed Analysis
Ultra Petroleum controls substantial acreage in and around the prolific Jonah natural gas field and the Pinedale Anticline area in the Green River Basin. Both of these areas are endowed with rich natural gas reserves, which have remained largely untapped to date. Ultra Petroleum’s production growth over the last few years highlights its attractive asset base. Last year, the company achieved record production of 257.0 billion cubic feet equivalent (Bcfe), representing a 5% year-over-year increase.
ltra Petroleum maintains a very competitive cost structure, which contributes to the consistency of its growth and returns throughout the business cycle. During 2012, the company reported all-in operating costs of $3.00 per million cubic feet equivalent (Mcfe) – one of the best in its peer group. As a result of Ultra Petroleum’s low cost base, it was able to achieve a 64% cash flow margin and a 29% net income margin amid low natural gas prices.
Concerned by the continuing volatility in gas prices, Houston, TX-based Ultra Petroleum’s capital program now focuses on the promising liquids-rich Niobrara Formation in Colorado in a major shift away from dry natural gas development. The company expects exploration and development expenditure to be around $415 million, roughly half of that expended in 2012.
However, we think that these factors are adequately reflected in the present valuation, leaving little room for meaningful upside from current levels.
Finally, Ultra Petroleum currently generates substantially all of its revenue, earnings and cash flow from the production and sale of natural gas and oil from its Pinedale and Jonah fields in Wyoming. Consequently, any significant downtime related to pipelines or processing plants in the region could adversely affect the company’s results.
Stocks That Warrant a Look
While we expect Ultra Petroleum to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Oasis Petroleum Inc. (OAS), Sanchez Energy Corp. (SN) and PetroQuest Energy Inc. (PQ) as good buying opportunities. These domestic upstream energy operators – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.
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