Forest Oil Misses, Volume Falls

Denver-based Forest Oil Corporation’s (FST - Analyst Report) first quarter 2012 earnings from continuing operations of 11 cents per share (excluding non-recurring items) missed the Zacks Consensus Estimate of 20 cents and the year-earlier number of 19 cents.

The lackluster performance was mainly due to the lower prices realized for natural gas as well as natural gas liquids (NGLs) and declines in net sales volumes, which were partially offset by the higher oil price.

Total revenue in the reported quarter decreased to $158.9 million from the year-ago level of $166.9 million, and came nowhere near the Zacks Consensus Estimate of $189 million.

Operational Performance

Net sales volumes decreased by 1% year over year to 337.3 million cubic feet equivalent per day (MMcfe/d) in the reported quarter, mainly due to production downtime in the Texas Panhandle associated with third party infrastructure issues. However, the company has been able to raise its liquid proportion of production, which comprises 32% of the total output versus 26% in the first quarter of 2011.

The average equivalent price per Mcf (including the effect of hedging) was $5.87, up from the year-ago realization of $5.57. Average realized natural gas price was $3.47 per Mcf, down 20% from the comparable prior-year quarter, and natural gas liquids (NGLs) were sold at $35.16 per barrel, flat compared to the year-ago quarter. However, average realized oil price was $100.80 per barrel, up 18.1% from the year-ago quarter.

During the quarter, production expenses increased 10.3% year over year to $1.39 per Mcfe. Unit general and administrative expenses increased 8.3% year over year to 39 cents per Mcfe. Depreciation and depletion expenses per unit increased 38% to $2.18 per Mcfe from $1.58 per Mcfe in the corresponding 2011 quarter.

Financials

At quarter end, Forest had $0.9 million of cash and cash equivalents with $1,804.5 million of long-term debt, representing a debt-to-capitalization ratio of 60.0% (up from 58.7% at the end of fourth quarter 2011).

Lone Pine Spin-off

During 2011, the company completed the spin-off of Lone Pine Resources Inc. (LPR - Snapshot Report). Subsequent to the initial public offering of Lone Pine on June 1, 2011, Forest owned approximately 82% of the outstanding shares of Lone Pine's common stock.

On September 30, 2011, Forest distributed, or spun off its remaining ownership in Lone Pine in the form of a pro rata common stock dividend to all Forest shareholders of record as of the close of business on September 16, 2011(the Record Date). Forest shareholders received 0.61248511 of a share of Lone Pine common stock for every share of Forest common stock held as of the close of business on the record date.

Outlook

We like Forest Oil’s initiatives to increase liquids production. The company’s focus on cost control and the upside from Granite Wash and the Missourian Wash interval position it well to weather the weakness in natural gas prices.

The company’s drilling results from its new Texas Panhandle oil zones and the Granite Wash "A" zone were well above its expectations, demonstrating strong hydrocarbon potential in the Texas Panhandle from 'new' zones. Except the success achieved in the Missourian Wash and Cleveland oil zones, the company also achieved success in the Tonkawa well, located in the Texas Panhandle.

However, with natural gas accounting for almost 70% of the total production in the first quarter of 2012, Forest Oil is exposed to the tentative outlook of the North American natural gas market. Its operations and cash flow are more sensitive to fluctuations in the market price for natural gas than to fluctuations in the market price for oil and NGLs.

Forest faces tough competition from SM Energy Company (SM - Analyst Report), which is expected to report first quarter 2012 results later in the day. We maintain our long-term Neutral recommendation on Forest Oil. However, the company holds a Zacks #4 Rank (short-term Sell rating).