Antero Resources (NYSE: AR) is one of the fastest-growing natural-gas producers in the country. After increasing output 18% last year, the driller expects its growth rate to accelerate to 20% over the next three years. Further, this isn’t growth for the sake of growth, since the company expects to produce a stunning $1.6 billion to $4.8 billion in free cash flow over that time frame, depending on commodity prices — which is a mountain of cash flow for an $11.4 billion company.
That said, despite Antero’s fast-paced growth, its shares are down 25% in the past year, even as commodity prices and its profitability have improved. Because of that, the company’s stock trades at an even deeper discount to rival drillers. In fact, the valuation disconnect has gotten so wide that the company is now looking at ways to address the issue.
Antero did the math, which showed that its stock is way too cheap. Image source: Getty Images.
Drilling down into the numbers
Earlier this week, Antero Resources announced that it had hired financial and legal advisors to: “Evaluate various potential measures to address the discount in trading value of Antero’s stock relative to some of the premier U.S. large capitalization upstream independents that have a similar profile in terms of leverage, capital efficiency, production growth and free cash flow generation.”
The company detailed this difference in valuation at its recent Analyst Day. First, it pointed out that the 51 publicly traded exploration and production (E&P) companies in the country sold for an average of 7.1 times their enterprise value to adjusted EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expenses), which is a common way to value E&Ps. Antero, however, sold at a discount to that group, since it trades at 5.1 times.
That said, the company further noted that there were six E&Ps that fetched premium valuations of 11.1 times EV/EBITDAX: EOG Resources, Concho Resources, Pioneer Natural Resources, Diamondback Energy, Cabot Oil & Gas (NYSE: COG), and Cimarex Energy. Each shared four commonalities that fueled their premium valuations:
- Scale: Each had an enterprise value of more than $10 billion.
- Growth: All were on pace to increase production by more than 15%.
- Low leverage: Each had leverage ratios of less than 2.0 times debt to EBITDA.
- Free cash flow generation: All were growing fast, while still producing excess cash.
What’s noteworthy about these factors is that Antero currently meets all but the leverage criteria, though it’s on pace to hit that next year. Because of that, the company strongly believes it should also trade at a premium multiple.
Exploring its options
While the company could continue waiting for the market to wake up to the fact that it’s an elite company deserving of a premium valuation, it’s exploring options that could accelerate this process. Among the measures it’s looking into are a return of capital to investors, such as initiating a dividend, or repurchasing shares.
That’s because a similar approach by natural-gas-producing peer Cabot Oil & Gas has helped ignite its stock to a 20% gain over the past year. While Cabot Oil & Gas has paid dividends for many years, the company has ramped up its payment in the past year, boosting it 150% in 2017 and another 20% in 2018. In addition to that, Cabot started repurchasing shares last year, and plans to continue buying back stock in 2018.
It’s not the only oil and gas company to benefit from launching a share-buyback program. E&P behemoth ConocoPhillips (NYSE: COP) unveiled a $3 billion buyback plan in November of 2016 and would go on to add $4.5 billion to it last year. Those repurchases, along with higher oil prices and an improvement in its operations, has pushed ConocoPhillips’ stock up 35% since that initial announcement.
Meanwhile, fellow E&P giant Anadarko Petroleum (NYSE: APC) announced a $2.5 billion repurchase program last September, which also helped push its stock up nearly 35% since that time. Given the tangible impact of these repurchases, it seems highly likely that Antero will follow this successful blueprint for increasing value.
Betting on a buyback
While Antero Resources has the scale, growth, balance-sheet strength, and cash flow of an elite energy company, it’s selling for an unjustifiable discount to those rivals instead of trading at a similar premium valuation. That’s leading the company to look for ways to address the discount.
A buyback is likely the quickest way to nudge shares in the right direction since it has already worked wonders for Cabot Oil & Gas, ConocoPhillips, and Anadarko Petroleum. That adds another compelling catalyst for what’s already a top natural-gas stock to consider buying for the long haul.