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Southwestern Performs as Expected

SWN CHK

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Southwestern Energy Co. (SWN - Analyst Report) has reported third-quarter 2011 earnings of 50 cents per share, which is in line with the Zacks Consensus Estimate. However, the quarterly results showed an 8.7% improvement from the year-earlier profit of 46 cents.

The year-over-year improvement was backed by production growth, primarily at its Fayetteville shale operations, accompanied with a focus on cost control.

Third-quarter revenues climbed approximately 12.5% to $767.3 million from the year-ago level of $682.2 million.

Production and Realized Prices

During the reported quarter, the company’s oil and gas production shot up nearly 23% year over year to 128.9 billion cubic feet equivalent (Bcfe), driven by the Fayetteville Shale operations. Production from Southwestern’s Fayetteville Shale play increased 21.2% to 111.9 Bcfe from the year-earlier period.

The company’s average realized gas price, including hedges, dropped 8% to $4.30 per thousand cubic feet (Mcf) from $4.67 per Mcf in the year-ago period. Oil was sold at $88.35 per barrel, up 18.8% from the year-earlier level of $74.37 per barrel.

Segmental Highlights

Operating income from the Exploration and Production (E&P) segment surged 5.4% to $228.5 million, buoyed by higher production volumes, which were partially toned down by higher operating costs as well as lower gas price realization.

On a per-Mcfe basis, lease operating expenses were marginally up at 86 cents from 85 cents in the year-ago period. On the other hand, general and administrative expense per unit of production dropped 11% year over year to 25 cents.

The Midstream Services segment’s operating income leaped 25% to $66.8 million from $53.4 million in the year-earlier quarter. The increase was driven by an improvement in gathering revenues related to the Fayetteville and Marcellus Shale plays.

Capex and Debt

The company spent $470.4 million in total capital expenditure in the quarter, of which $421.2 million was invested toward E&P activities and $32.2 million for the Midstream segment.

As of September 30, 2011, long-term debt stood at $1,271 million, representing a debt-to-capitalization ratio of 26% (versus 27% in the preceding quarter).

Hedging

At October 25, 2011, Southwestern had approximately 80 Bcf of its remaining 2011 projected natural gas production hedged at a weighted average floor price of $5.21 per Mcf.

The company also had approximately 266 Bcf and 185 Bcf of its 2012 and 2013 expected gas productions hedged at an average floor price of $5.16 and 5.06 per Mcf, respectively.

Guidance

Solid performance from the Fayetteville Shale and Marcellus Shale operating areas has prompted Southwestern to raise its 2011 production expectation in the range of 496 to 500 Bcfe from 483 Bcfe to 491 Bcfe. The increased outlook also represents a 23% increase over the 2010 level. The company has also lifted its fourth quarter oil and gas production estimate to 129–133 Bcfe from 126–130 Bcfe.

Our Take

Southwestern’s industry-leading holdings in Northern Arkansas’ Fayetteville Shale play make it one of the highest quality natural gas discoveries in North America in the recent years. For 2011, the company expects approximately 430–434 Bcf of the total hydrocarbon volume to come from the Fayetteville Shale. Marcellus and Fayetteville shales also hold ample opportunities for newer natural gas discoveries.

We see the company as well positioned for production growth given its streamline cost structure, upcoming drilling programs in the Fayetteville and Marcellus shales and a wide acreage in its New Ventures. During the reported quarter, Southwestern's Marcellus shale operations in northeastern U.S. produced 7.4 Bcf, 36 times higher than last year's output. In Arkansas, Fayetteville shale output improved 27% to 1.9 Bcf.

However, we remain apprehensive regarding the weak natural gas scenario in the U.S. arising out of continued oversupply and low demand for natural gas. This will likely impede the company’s performance in the near term.

Other risk factors include weaker-than-expected commodity prices, technological failures and the lack of a diversified asset base. Competition from its peers, such as Chesapeake Energy Corporation (CHK - Analyst Report), also remains a cause for concern.

The company holds a Zacks #3 Rank (short-term Hold rating). We also maintain our long-term Neutral recommendation on the stock.

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