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Forest Suffers on Lower Gas Price

FST

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Denver-based Forest Oil Corporation’s (FST - Analyst Report) second quarter 2012 earnings of 6 cents per share (excluding non-recurring items) decreased significantly from the year-earlier earnings of 25 cents. The lackluster performance was mainly due to the lower prices realized for natural gas as well as natural gas liquid (NGL). However, the quarterly figure came slightly ahead of the Zacks Consensus Estimate of 5 cents.

Total revenue in the reported quarter decreased to $135.7 million from the year-ago level of $186.9 million, and failed to meet the Zacks Consensus Estimate of $158.0 million.

Production

Net sales volumes remained flat year over year at 335.4 million cubic feet equivalent per day (MMcfe/d) in the reported quarter, mainly due to production downtime related to a fire at Eagle Rock’s Phoenix-Arrington Ranch natural gas processing facility in Hemphill County, Texas.

However, the company has been able to raise its oil net sales volume, which organically increased 27% from the year-ago period to 8.3 million barrels per day (MBbls/d) but decreased 1% sequentially. Natural gas sales volume shrunk 4.9% year over year to 229.4 MMcf/d, and comprised 68% of the total quarterly volume.

Realized Prices

The average equivalent price per Mcf (including the effect of hedging) was $5.46, down almost 12% from the year-ago realization of $6.20. Natural gas was sold at $3.20 per Mcf, down 32.2% from the comparable prior-year quarter, and natural gas liquids (NGLs) were sold at $30.06 per barrel, down 17.1% from the year-ago quarter. However, average realized oil price was $98.21 per barrel, up 5.5% from the year-ago quarter.

Expenses

During the quarter, production expenses decreased 5.4% year over year to $1.23 per Mcfe. Unit general and administrative expenses increased marginally year over year to 35 cents per Mcfe from the year-ago level of 34 cents per Mcfe. Depreciation and depletion expenses per unit increased 39% to $2.39 per Mcfe from $1.72 per Mcfe in the second quarter of 2011.

Financials

At quarter end, Forest had $0.7 million of cash and cash equivalents with $1,938.9 million of long-term debt, representing a debt-to-capitalization ratio of 73.6% (up from 60.0% at the end of first quarter 2012).

Company Outlook

Earlier, the company highlighted that it plans to trim its spending rate as well as divest non-core properties during the second half of the year. This is needed to boost its financial strength and flexibility.

The company expects capital expenditure between $190 million and $210 million for the second half of 2012, down from the spending level of $435 million in the first six months of the year. Forest Oil intends to spend less in lower return liquids projects in East Texas and in the Panhandle area.

Additionally, Forest Oil aims to slash costs by reducing the number of rigs to just two from five at present in the Panhandle area by the fourth quarter of 2012. It will also likely have one rig operating in East Texas, compared with the two rigs there at present.

The next step needed to stabilize its financials will depend on identification and divestiture of non-reserve based and non-core assets in the near future. It will likely offload its properties to get rid of a $1.8 billion debt load.

Lone Pine Spin-off

During 2011, the company completed the spin-off of Lone Pine Resources Inc. . 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 registered impressive results from its Hogshooter and Cleveland oil plays in the Panhandle Area and from its Eagle Ford program. Forest Oil intends to spend the remaining capital budget for the year mainly towards the higher-margin oil ventures. It also expects to deliver oil volume growth of 10-15% in the next half of the year versus the first half.

Although the company has already started reducing its spending level for lower-return liquids and natural gas projects, we remain skeptical about its natural gas weighted production level. As natural gas accounted for 68% of the company’s total production in the second quarter of 2012, Forest Oil is exposed to the cautious 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.

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

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