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We reaffirmed our Neutral recommendation on Southwestern Energy Company (SWN - Analyst Report) on Sep 13, 2013.  The company’s strong acreage positions in the Fayetteville and Marcellus shale plays remain subdued by its natural gas weighted production as well as reserves profile. The stock retains a Zacks Rank #3, which is equivalent to a short-term Hold rating.

Why Maintained?

Southwestern Energy is one of the largest producers of natural gas in the U.S., with core Fayetteville Shale properties spreading over 913,502 net acres. On Aug 2, the company reported better-than-expected second-quarter 2013 earnings mainly on the back of higher production, primarily at its Fayetteville Shale operations. Lower operating expenses also aided the outperformance.

During the quarter, 126 Fayetteville wells came on-stream, driving production of 2,027 million cubic feet (MMcf) per day. Notably, the costs averaged $2.3 million per well with average time to drill of 6.2 days. With an efficient management team, the company’s low-cost operations exhibit a solid upside potential. This has helped Southwestern to maintain its full-year total production target in the 643–651 billion cubic feet (Bcf) range, or 15% above the 2012 level.

Southwestern is investing heavily in the development of the fertile Marcellus play, where it holds leases of approximately 337,300 net acres. Subsequently in May, the company acquired approximately 162,000 net acres in the Marcellus Shale in Pennsylvania from Chesapeake Energy Corporation. The production from the region averaged 33.9 Bcf in the second quarter, compared to 9.9 Bcf in the prior-year quarter. The company expects to spend approximately $705 million to drill 86–88 gross wells in Marcellus. Southwestern has almost doubled its expected gas production to160–165 gross Bcf in 2013 as compared to 2012.

Southwestern boasts a strong balance sheet with significant liquidity and financial flexibility. Moreover, the company’s continuous endeavor of focusing on return on investment, coupled with its large drilling inventory, uniquely positions it to create significant value for shareholders. Southwestern remains focused on generating economic returns. It is committed to projects returning at least 1.3x the present value index and intends to only drill projects that meet that return threshold.

However, taking into account the uncertain price fundamentals for natural gas plus drilling challenges, we see little room for above-market performance.

Other Stocks to Consider

There are other stocks in the sector that appear rewarding. These include China Petroleum & Chemical Corp. (SNP - Analyst Report), SM Energy Company (SM - Analyst Report) and Whiting Petroleum Corp. (WLL - Snapshot Report), which are expected to perform impressively over the next few months and carry a Zacks Rank #1 (Strong Buy).

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