Spring Sale
Natural gas prices have come down significantly in the last few weeks, mainly due to warmer weather. As a result, gas-led TSX energy stocks have notably tumbled of late. One of them is ARC Resources (TSX:ARX), Canada’s third-largest natural gas producer. After a massive outperformance last year, ARX stock has dropped 20% since December 2022. Let’s see if the recent weakness poses any buying opportunities for new investors.
Production mix
ARX intends to produce 350,000 barrels of oil equivalent per day in 2023, approximately 3% higher than in 2022. Along with gas, the company produces a large amount of condensate. Condensate usually trades at a premium to WTI and a much higher premium to WCS (Western Canadian Select) oil, which many Canadian oil producers receive. This helps bring in higher revenue and margins compared with those of peers. Almost 40% of its production is liquids-weighted (oil+ condensate+ natural gas liquids).
Financial growth
Thanks to higher oil and gas prices, energy-producing companies have seen massive financial growth since the pandemic. ARX is no exception. For the last 12 months, it reported free cash flows of $2.2 billion, marking momentous 131% growth compared to 2022.
ARC Resources will release its Q4 2022 earnings next month. It will be interesting to see how lower gas prices during the quarter impact its financial growth. Notably, its larger proportion of revenues from oil and condensate will likely make it less vulnerable to falling gas prices.
The oil and gas producer plans to allocate 50%–100% of its free cash flow to shareholder returns, after achieving its deleveraging target last year. Driven by excess free cash flow last year, energy companies repaid debt in the last two years. Now that their balance sheets have achieved a superior financial position, much of the incremental cash will go towards higher dividends or buybacks.
Dividends
ARX pays a quarterly dividend of $0.15 per share, indicating an annualized yield of 3.8%. Along with dividends, share repurchases will likely help the stock price, ultimately boosting shareholder returns. ARX has bought back 13% of its total outstanding shares since September 2021. The lower share count boosts the company’s per-share earnings and increases existing investors’ claims on dividends.
Total returns
ARX stock has returned 18% in the last 12 months, while peer TSX energy names have returned 35%. A larger drawdown in gas prices has led to this underperformance. Since the pandemic, energy names have notably outperformed broader markets.
This year as well, oil and gas-producing companies will likely outperform due to their earnings growth visibility and relatively lower inflation pressures.
Valuation
ARX stock looks appealing once again from a valuation standpoint after its recent fall. It is currently trading at a free cash flow yield of 18%, higher than peers’ average of 16%. On the price-to-earnings front, it is currently trading at 4x and looks undervalued.
Should you buy ARX stock?
Natural gas prices could remain weak in the short term, weighing on gas producer stocks. However, the latter half of 2023 could be encouraging for gas investors as supply concerns, particularly in Europe, start sending prices north again. ARX is a fundamentally attractive name driven by its strong asset quality, strengthening balance sheet, and earnings growth prospects.
