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Independent natural gas operator, Southwestern Energy Co. (SWN - Analyst Report) reported fourth-quarter 2012 earnings of 44 cents per share, exceeding the Zacks Consensus Estimate by a penny mainly on higher production, primarily at its Fayetteville shale operations. The quarterly results, however, decreased from the year-earlier profit by a cent. The decline was primarily due to the drop in natural gas prices.

Full-year 2012 earnings plunged 23.6% year over year to $1.39 per share from $1.82 in the prior year. However, full-year earnings beat the Zacks Consensus Estimate by a penny.

Fourth-quarter revenue increased 3.9% to $773.0 million from the year-ago level of $744.2 million and comfortably surpassed the Zacks Consensus Estimate of $728.0 million.

Fiscal 2012 revenue was $2,715.0 million, down 8.1% year over year. The annual revenue came in above the Zacks Consensus Estimate of $2,665.0 million.

Production and Realized Prices

For full-year 2012, Southwestern’s oil and gas production was 565 billion cubic feet equivalent (Bcfe), up 13% from 500 Bcfe in the prior year.

During the reported quarter, the company’s oil and gas production grew more than 12% year over year to 149.9 billion cubic feet equivalent (Bcfe) – almost entirely gas – driven by the Fayetteville Shale operations. Production from Southwestern’s Fayetteville Shale play increased 7.4% to 125.1 Bcfe from the year-earlier period.

The company’s average realized gas price, including hedges, dropped almost 8% to $3.72 per thousand cubic feet (Mcf) from $4.04 per Mcf in the year-ago period. Oil was sold at $98.17 per barrel, up 1.7% from the year-earlier level of $96.49 per barrel.

At the end of 2012, oil and gas proved reserves were 4,018 million barrels of oil equivalent compared with 5,893 million barrels at the end of 2011. About 100% of the Southwestern’s estimated proved reserves were natural gas, of which 80% were classified as proved developed at year-end 2012. During 2012, the Corporation added 919.5 Bcfe to proved reserves. These additions replaced approximately 163% of its production.

Segmental Highlights

Operating income for the Exploration and Production (E&P) segment improved 0.5% year over year to $196.8 million in the fourth quarter. The increase was due to an increased output level, partially offset by lower gas price realization as well as higher operating costs and expenses related to production growth.

On a per-Mcfe basis, lease operating expenses were 81 cents versus 84 cents in the prior-year quarter. On the other hand, general and administrative expense per unit of production decreased by nearly 14% year over year to 25 cents.

The Midstream Services segment’s operating income jumped 14.9% to $77.7 million in the fourth quarter from $67.6 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’s total capital expenditure in 2012 was approximately $2.1 billion, of which $1.9 billion was invested in E&P activities and $165 million in the Midstream segment.

As of Dec 31, 2012, long-term debt stood at $1,668.3 million, representing a debt-to-capitalization ratio of 35.5% (versus 34.3% in the preceding quarter).

Hedging

As of Feb 20, 2013, Southwestern had approximately 185 Bcf of its 2013 expected gas production hedged at an average floor price of $5.06 per Mcf. It has hedged approximately 55 Bcf of its 2014 expected gas production at an average floor price of 4.43 per Mcf.

Guidance

Southwestern has issued production guidance for 2013 in the range of 628 Bcfe to 640 Bcfe. The outlook represents an 11% to 13% increase over the 2012 level.

Our Take

Southwestern’s industry-leading holdings in Northern Arkansas’ Fayetteville Shale play offer some of the highest quality natural gas discoveries in North America in recent years. Marcellus and Fayetteville shales also hold ample opportunity for newer natural gas discoveries.

We see the company as well positioned for production growth given its streamlined cost structure, upcoming drilling programs in the Fayetteville and Marcellus shales, and a wide acreage in its New Ventures, especially in the Brown Dense play.

However, we remain apprehensive about the weak natural gas scenario in the U.S. given the continued oversupply and low demand. This will likely hurt the performance of the company as well as of other natural gas companies like Chesapeake Energy Corporation (CHK - Analyst Report) in the near term.

Other risk factors include weaker-than-expected commodity prices, technological failures and the lack of a diversified asset base.

The company holds a Zacks Rank #3 (Hold). However, there are other stocks in the oil and gas sector – The Laclede Group, Inc. (LG - Snapshot Report) and Lehigh Gas Partners LP (LGP - Snapshot Report)  – which hold a Zacks Rank #1 (Strong Buy) and are expected to perform better.
 

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