Coterra Experiences Weak Near-Term Natural Gas Environment

We’re reducing our fair value estimate for Coterra CTRA to $23 from $25 after taking a second look at the firm’s fourth-quarter earnings and incorporating the recent slump in commodity prices, especially on the natural gas side. Coterra generated $3.9 billion in free cash in 2022, and distributed 82% of it to shareholders (50% dividends and 32% buybacks). But that now looks like a high-water mark, with natural gas prices collapsing by 50% since the end of last year. At strip prices, we expect around $1.5 billion in surplus cash during 2023, and it still intends to return at least half of that to shareholders, but this year buybacks will the priority rather than variable dividends. We’re relatively agnostic on the method of distribution while shares are close to fair value, but note the potential for management to get carried away during upcycles if buybacks are the primary return mechanism, when the firm has more cash typically and when the stock is likely to be more richly valued as well.

As a reminder, the firm’s fourth-quarter oil and natural gas volumes both exceeded the respective guidance ranges, while total volumes were within guidance. The implication is that natural gas liquid volumes were lower than expected, most likely due to increased ethane rejection (which means the lightest NGL component was left in the natural gas stream and sold as gas). This unwinds a trend for more NGL recovery in the last few quarters and is consistent with previous commentary from management. We’d categorize this result as outperformance on the oil side and consistent with expectations on the gas side, which is a positive surprise overall. The firm’s financial results were slightly better than FactSet consensus estimates, too.