This Natural Gas Producer Will Power Pipeline Dividends

Dividend investors don’t typically look to a stock that pays 8 cents per year for income. Especially when that dividend means the stock yields just 0.23% annually.
But when that stock is Cabot Oil and Gas (NYSE:COG), the largest natural gas producer in the Marcellus shale, income investors should dig a little deeper. That’s because Cabot’s growing natural gas production is leading higher-yielding pipeline operators to expand their infrastructure – and that means more cash flow to support their dividend payments.
As Cabot nearly doubles the amount of natural gas it sends to market over the next five years, the company’s growing production will power dividends for the pipeline operators that transport the gas. These companies offer the higher yields, between 3% and 6%, that income investors often seek.
Additionally, for those investors looking for a growth-oriented investment with significant dividend growth potential, Cabot is a definite “buy”.
Cabot has more than 3,000 drilling locations in the sweetest spot of the Marcellus Shale; good enough for 25 more years of drilling. These super-rich locations enable Cabot to be a low-cost producer, largely because the company recognized the potential early and got in before many competitors.
Due to rapid production growth, Cabot is going to be contributing a sizeable quantity of natural gas to pipeline operators in the northeast for the foreseeable future. Those operators include Kinder Morgan (NYSE:KMI), Williams Companies (NYSE:WMB) and WGL Holdings (NYSE:WGL).  We’ll talk more about those companies in a minute. But first, this is why you might want to consider COG as well.
Cabot’s fourth quarter profit rose by a whopping 90% to $78 million as natural gas production climbed by 56%. Full-year net income of $280 million, or $0.67 per share, was up 115% over the previous year. Beside the impressive top and bottom-line growth, two operating metrics separate Cabot from many other natural gas producers.
First, the company is consistently able to improve natural gas recoveries from its Marcellus wells. In 2013, the company’s average recovery per well increased by 20% to 16.9 billion cubic feet equivalent (Bcfe) – more than three-times that achieved in 2008. Improvement in recoveries is largely the result of Cabot’s move to longer lateral wells – a trend it will continue in 2014.
Second, Cabot has once again decreased cash costs, by 26% in the fourth quarter (as compared to the year ago quarter).
The net effect of these two operating efficiencies is that Cabot’s pre-tax returns exceed 100%, based on a $3 natural gas price. By comparison, Range Resources (NYSE:RRC) and Chesapeake Energy (NYSE:CHK) require natural gas prices of $4 to generate 100% returns. In other words, it’s far easier for Cabot to turn a profit than the competition.
The problem for COG, and the opportunity for income investors, is that infrastructure limitations still harm its ability to get a good price for gas. Even though gas prices were higher in 2013 than 2012, Cabot only received $3.44 per unit of gas in the fourth quarter. That’s a 12% decline from the price received in the fourth quarter of 2012.
The solution to this problem is to improve takeaway capacity. And this is where things get interesting for investors over the next three years. Numerous marketing projects should dramatically improve Cabot’s ability to get natural gas to market at a fair price.
Four infrastructure projects with partners that already transport the vast majority of Cabot’s natural gas, including Williams Companies and Kinder Morgan, should add daily delivery of 550,000 MMBtu via interstate pipelines.
Cabot has also executed an agreement with WGL Holdings’ subsidiary, Transcontinental Gas Pipeline (Transco), to move gas from the Marcellus. This deal will help COG move gas to Washington D.C. and the Cove Point LNG export terminal in Maryland via Transco’s “Atlantic Sunrise” expansion project.
All in, that new agreement will add an additional 850,000 MMBtu per day of pipeline capacity. And it allows COG to participate in the project as a 20% equity owner too.
WGL Holdings expects the Atlantic Sunrise project to fire up service in 2017. The project represents WGL’s second large natural gas infrastructure investment within the last nine months. The company has a market cap of $2.07 billion and pays a 3.6% dividend.
The combined impact of all of these projects should allow Cabot to increase daily distribution by 90%. And also allow the company to increase its dividend – not to mention add incremental growth and dividend-paying capacity to COG’s partners, including Kinder Morgan (current yield of 5.1%), Williams Companies (current yield of 3.9%) and WGL Holdings (current yield of 4.4%).
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