Concerns over low natural gas prices are obscuring the long-term potential of Rice Energy's high-quality asset base, says Morningstar’s David Meats.
David Meats: We recently raised our fair value estimate for Rice Energy to $16 per share after reviewing the firm's fourth-quarter financial and operating results. EBITDA was $126 million in the quarter, which is 86% higher year on year and was fractionally ahead of consensus estimates. Production was 57% higher relative to the equivalent prior-year period as well. But the biggest driver for the increase in our valuation was the improving outlook for production from new gas wells drilled in Rice's core Marcellus and Utica acreage.
The firm has updated its choke management program. Essentially, this means capping production from new wells at a lower rate to protect the reservoir and lower decline rates, resulting in greater recoveries over time. The result is a 9% increase to the cumulative production of a Marcellus well over its lifetime and a 5% increase in the same for a Utica well. We believe that this improves the net present value of these wells, and incorporating these revised projections into our model supports a higher net asset value. As a result, the stock now looks undervalued at the current level.
Investors should be aware that natural gas prices, which underpin most of Rice Energy’s revenues, are at historical lows. And the firm's realized prices are weakened further by challenging basis differentials in the Appalachian basin that Rice operates in. However, management has sidestepped the brunt of these challenges with an extensive portfolio of hedges, as well as firm transport and sales contracts that enable the company to ship its production to premium markets outside of the basin. Even so, the challenging commodity price environment has driven the firm's leverage above the peer group average, although there's no shortage of liquidity in place, and in the long run we expect that a favorable combination of higher prices and growing production will enable the firm to strengthen its balance sheet. We believe the market is too preoccupied with manageable near-term borrowing and failing to appreciate the full potential of Rice's high-quality natural gas acreage.
