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EQT: 4 Key Takeaways From The Q3 2015 Investor Call

EQT reported a tough Q3/15 but that much was expected – the important updates were given on the investor call that followed the financial updates. EQT, even in advance of presentations to its Board, was able to be granular with forward-looking expectations. I have to wonder about risk management of an EQT position at this point in time – I wonder if investors shouldn’t be managing total capital exposure. EQT (NYSE: EQT ) is out with a tough quarter. Still, much of what EQT reported was expected as the energy sector continues into what have been historically punitive pricing environments. That said, the Q3/15 reporting exemplifies perfectly the pressure that even quality E&Ps like EQT are under: Q3/15 adjusted loss of $0.33 per diluted share, representing a $0.83 per share decrease Y/Y Q3/15 adjusted operating cash flow of $156.3 million, a 46% decrease Y/Y Q3/15 adjusted operating revenues of $188.5 million, a $142.5 million reduction Y/Y Production sales volumes increased 27% compared to the third quarter of 2014 Average realized price of production of $1.21/mcfe, a 55% decrease from $2.69/mcfe Y/Y With EQT’s financials being expected as reported, this placed an extra importance on the investor call that followed the financial reporting. EQT CEO David Porges, SVP & CFO David Conti, and EVP & President of E&P Steven Schlotterbeck did well to cover a wide range of topics on the call. The team also did well to break out as much of the go-forward strategy at the E&P as possible in advance of a presentation of this information to the Board in roughly six weeks. Put simply, without having Board approval, and with being respectful to not presume Board approval, the management team tried to be as granular as possible. The following is my analysis of the key takeaways. Capital Plans and Play Deployment… “Given this potential for lower long-term gas prices, we do not think it’s prudent to invest much money in wells whose all-in after-tax returns exceed our investment hurdle rates by only a relatively small amount. As a result, we are suspending drilling in those areas such as Central Pennsylvania and Upper Devonian play that are outside that core. This decision will affect our 2016 capital plan though we are just starting to develop the specifics of the 2016 drilling program that forms the core of that plan. The focus in 2016 will be on this more narrowly-drawn notion of what the core Marcellus would be assuming the deep Utica play works… We will also pursue the deep Utica play with a goal of determining economics, size of resource that midstream needs and on lowering the cost per well to our target range. Our initial thoughts are a 10 well to 15-well deep Utica program in 2016 with flexibility to shift capital between Marcellus and Utica as warranted based on our progress… I feel uncomfortable putting numbers out there when we’re still what six weeks away from putting numbers in front of our own board. But if you’re looking for directional, it would be – clearly we’re heading less than 2015” A few things were made clear by Porges early on in the call. The first, that EQT is taking operations quite literally day by day. The second, that EQT has to do something regarding what are near-zero ( maybe even negative IRR) after-tax Core Marcellus IRRs on production (SEE: graphic below – current NYMEX is $2.29). I want to think that the returns outlined in EQT’s October investor deck are a blended core rate, but the slide is pretty clearly labeled “Core Marcellus”. If that’s the case, I’m having a hard time seeing where EQT can deploy capital that can be productive . That said, I think Porges was alluding to this as well. He and EQT aren’t willing to continue to invest in wells of this ilk and obviously that’s the only decision that makes sense. In that, EQT is looking to move into its Utica assets (which it believes are deep core) in an effort to begin averaging up IRRs at current NYMEX spot. The big takeaways here? EQT is hurting in a big way on Marcellus production and EQT is going to begin looking elsewhere for the derisking of production. This makes full-year 2016 one of the riskiest on record for the company. Stay tuned here. (click to enlarge) Capital Plans and Play Deployment PART 2: Investments into the Future… “Yeah, we look at all-in return. All-in after-tax returns is the way we tend to look at things. But that overlay that I mentioned in my prepared remarks was we just think we need to bear in mind what if the deep Utica works and what does that mean for clearing prices, et cetera, and therefore we should be particularly cautious about investing in anything but the core Marcellus which does stand up still in those environments and in the core Utica. So, it’s more of that. There’s always uncertainty about what prices are going to be. But whenever you have a new low-cost supply source in any commodity business, you’ve got to start being wearier of where one wants to invest one’s money. So, I think there’s a certain amount of caution that we’re taking that we’re talking about because of that unknown because of not knowing yet the extent to which the deep Utica will work… But our feeling that if it works the way it’s looking like it might that the core areas for Marcellus and Utica are simply going to be narrower. I mean, we’re going to be able to supply a big portion of North America’s natural gas needs from a relatively small geography.” This is hugely important and for me this is a reason to either risk off EQT, even assuming serious mean reversion to 52-week highs on oil beta and then natural gas beta, OR to manage total capital exposure (this can be done using CALL and PUT options as well). For me, Porges is alluding that the Marcellus is staring at potential disruption from the Utica. The Utica core, which EQT does have exposure to and that’s important to remember, is expected to be much, much more cost effective from a production standpoint (at least for EQT) than the non-Marcellus core production at the E&P currently. Porges believes that if the Utica core plays out how it is expected that the Marcellus core by comparison will shrink substantially. Outside of the Marcellus core, because of geographical proximity, it just wouldn’t be competitive to produce in the Marcellus . That matters in a big, big way for EQT. Again, this total uncertainty and required conservatism, which is smart, to me makes the full year one of the riskiest ever at EQT. Be careful when staring in the face of disruption. Production Estimates… “Our preliminary estimate for production volume growth in 2016 versus 2015 is 15% to 20% which we will refine when we announce our formal development plan at early December. If we turn online our fourth quarter wells in late December, as contemplated in our fourth quarter guidance, 2016 growth would likely be near the upper end of that range as those wells would contribute little if anything to volumes until early 2016. Obviously, this overall approach will result in a 2016 capital budget, absent any acquisitions that is a fair bit lower than 2015 and would result in continuing (16:28) of cash on hand as of end 2016 but we will provide specifics in December.” So this was short but meaningful. Keeping with the theme of “day by day” management, the only certainty at EQT at this point is lower CAPEX and potentially 15%-20% production increases based on 2015 activities. EQT isn’t willing, and this makes some sense being in advance of its Board presentations, to commit to any production increases from 2016 activities. At least that’s my read. My guess is, and I’ll reserve the right to be wrong about this, that EQT’s production growth doesn’t come anywhere near the top-end of this range and that its CAPEX sees not one but two big cuts into 2H/16 (the conclusion of 1H/16). I just don’t see the above-noted conservatism and overall NYMEX spot expectations as being productive to increased production. M&A… “Finally, the deep Utica potential has also affected our thoughts around acreage acquisitions. Given our view that our existing acreage sits on what is expected to be the core of the core in deep Utica, we are focusing our area of interest even more tightly on acreage that is in our core Marcellus and potentially core deep Utica area. As you can probably deduce from the lack of significant transaction announcements, the bid/ask spread continues to be wide… We are a patient company and believe that there will be acreage available at fair prices eventually. But the definition of fair has to contemplate the potential that the deep Utica works. We do not think that bodes well for that price of acreage concentrated in anything but the core Marcellus and core Utica. This narrowing focus also suggests that smaller asset deals are much more likely than larger corporate deals. However, as we have stated previously, we are comfortable maintaining our industry-leading balance sheet even as we look for opportunities to create value.” (Steven T. Schlotterbeck – Executive Vice President and President of Exploration & Production) “So, right now, it seems like there’s – people are interested in selling assets. So far, the prices have still been a bit high. But as Dave said, we plan on being patient waiting for what we would consider fair prices before we transact.” Porges’ thoughts here are basically what those following this space have been hearing dating back to November of 2014. The bid/ask spreads are too wide and continue to be too wide for increased M&A velocity. I outlined this dynamic in a recent Exxon Mobil (NYSE: XOM ) note , detailing how Exxon has used this spread to its advantage. That said, if we continue into a lower for longer (which, of course, is the expectation of this space), look for EQT to be in position to take assets at even further firesale prices as those currently marketing assets will likely have to take lower subsequent pricing as their balance sheets continue to degrade in structural integrity. That would bode well for longer-term EQT investors, as EQT might be able to “reset” its blended Utica/Marcellus IRRs by force rather than by organic development . If EQT can bid away core Utica acreage (assuming production does prove out to be more competitive in size than core Marcellus production), this would derisk its Marcellus-focused model significantly and have the E&P back on the board as one of the safest plays in this space (natural gas focused from a resource standpoint). That’s the big takeaway from this excerpt. That and EQT might be able to play a lower for longer, which is punitive to its financials in the immediate term, into securitization of seriously competitive long-term viability. It’s just as beneficial sometimes to be lucky as it is to be good. Again, stay tuned. Summary Thoughts… I’ve been an EQT bull in the past and I’m not implying anything of catastrophic risk in the immediate or the mid-term. I believe in EQT’s balance sheet, management, and operations as-is currently. But, and this is important, if the Utica usurps the Marcellus as the low cost, prolific production source in the geographic area, that’s going to matter in a big way for EQT. With EQT management being clear about that on the Q3/15 investor call, I think investors should take into consideration what that should mean to risk management. I would recommend taking a hard look at capital exposure to this name and at considering hedging that exposure via CALL or PUT options. I just view the EQT story as having significant implied risk at this point (if not real risk). I’ll closely follow this E&P for updates and provide analysis as possible. Good luck everybody.

Resilient Consumer? Not During The Manufacturing Retreat And Corporate Revenue Recession

Is the 70% consumer so resilient that he/she can overcome a global slowdown, a stagnant domestic manufacturing segment and a domestic revenue recession. Six of the regional Fed surveys – New York (Empire), Philadelphia, Kansas City, Dallas, Chicago and Philly – show economic contraction in manufacturing. The expected revenue for the S&P 500 for the third quarter is headed for a third straight quarterly decline at 3.3%; the 4th quarter should show a 1.4% decline to make it four in a row. Concerned investors started punishing foreign stocks and emerging market equities in May. The primary reason? Many feared the adverse effects of declining economic growth around the globe as well as the related declines in world trade. By June, risk-averse investors began selling U.S. high yield bonds as well as U.S. small cap assets. A significant shift away from lower quality debt issuers troubled yield seekers, particularly in the energy arena. Meanwhile, the overvaluation of smaller companies in the iShares Russell 2000 ETF (NYSEARCA: IWM ) prompted tactical asset allocators to lower their risk exposure. All four of the canaries (i.e., commodities, high yield bonds, small cap U.S. stocks, foreign equities) in the investment mines had stopped singing by the time the financial markets reached July and early August. I discussed the risk-off phenomenon in August 13th’s ” The Four Canaries Have Stopped Serenading.” What had largely gone unnoticed by market watchers, however? The declines were accelerating. And in some cases, such as commodities in the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ), investors were witnessing an across-the-board collapse. The cut vocal chords for the canaries notwithstanding, there have been scores of warning signs for the present downtrend in popular U.S benchmarks like the S&P 500 and Dow Jones Industrials. Key credit spreads were widening, such as those between intermediate-term treasury bonds and riskier corporate bonds in funds like the iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) or the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ). Stock market internals were weakening considerably. In fact, the percentage of S&P 500 stocks in a technical uptrend had fallen below 50% and the NYSE Advance-Decline Line (A/D) had dropped below a 200-day moving average for the first time since the euro-zone’s July 2011 crisis. (See Remember July 2011? The Stock Market’s Advance-Decline Line (A/D) Remembers. ) Equally compelling, any reasonable consideration of fundamental valuation pointed to an eventual reversion to the mean; that is, when earnings or sales at corporations are rising, one might be willing to pay an extraordinary premium for growth. On the other hand, when revenue is drying up and profits per share fall flat – or when a global economy is stagnating or trending toward contraction – investors should anticipate prices to fall back toward historical norms. Indeed, this is why 10-year projections for total returns on benchmarks like the S&P 500 have been noticeably grim. Anticipating the August-September volatility – initial freefall, “dead feline bounce” and present retest of the correction lows – has been the easy part. When fundamental valuations are hitting extremes, technicals are deteriorating, sales are contracting and economic hardships are mounting, sensible risk managers reduce some of their vulnerability to loss. It is the reason for my compilation of warning indicators (prior to the downturn) in Market Top? 15 Warning Signs . Anticipating what the Federal Reserve will do next is a different story entirely. The remarkably low cost of capital as provided by central banks worldwide is what caused the investing community to dismiss ridiculous valuations and dismal market internals up until the recent correction. Now Fed chairwoman Yellen has explicitly acknowledged that the U.S. is not an island unto itself. The fact that half of the developed world in Europe, Asia, Canada, Australia are staring down recessions – the reality that many important emerging market nations are already there – has not slipped by members of the Federal Reserve Open Market Committee (FOMC). Unfortunately, the Fed’s problem with respect to raising or not raising borrowing costs does not end with economic weakness abroad. With 0.3% year-over-year inflation in July, the Fed’s 2% inflation target has been pushed off until 2018. With 0.2% year over year wage growth (or lack thereof), the Fed’s hope that consumer spending can save the day looks like wishful thinking. For that matter, as I demonstrated in 13 Economic Charts That Wall Street Doesn’t Want You To See , consumer spending has dropped on a year-over-year basis for 4 consecutive months as well as six of the last eight. Perhaps ironically, I continue to receive messages and notes from those who insist that the U.S. consumer is in fine shape. Even if he/she is stumbling around at the moment, he/she is consistently resilient, they’ve argued. I would counter that three-and-a-half decades of U.S. consumer resilience is directly related to lower and lower borrowing costs. Without the almighty 10-year yield moving lower and lower, families that have been hampered by declining median household income depend entirely on lower interest rates for their future well-being. Even with lower rates, perma-bulls and economic apologists will tell you that housing is in great shape. With homeownership rates now back to 1967? They’ll tell you that autos are in great shape. On the back of subprime auto loans with auto assemblies at a four-and-a-half year low? Wealthy people and foreign buyers have bought second properties, which have priced out first-time homebuyers. More renters than ever have seen their discretionary income slide alongside rocketing rents. And the only thing we’re going to hang our U.S. hat on is unqualified borrowers who cannot get into a house, but can get into a Jetta? (Yes, I intended the Volkswagen reference.) I am little stunned when I see people ignoring year-over-year declines in retail sales as well as the lowest consumer confidence readings in a year to proclaim that “everything is awesome.” If everything were great, the U.S. economy would not have required $3.75 trillion in QE or $7.5 trillion in deficit spending since the end of the recession. The Fed would not have needed 6-months to prepare investors for tapering of QE3 and another 10 months to end it; they would not have needed yet another year to get to the point where they’re still not comfortable with a token quarter point hike. The U.S. consumer requires ultra-low rates to get by, and that’s a sad reality with multi-faceted consequences. In my mind, it gets worse. Those who commonly fall back on the notion that 70% of the economy is driven by consumer activity seem to ignore the other 30% entirely. Manufacturing is falling apart. Year-over-year durable goods new orders? Down for seven consecutive months. Worse yet, six of the regional Fed surveys – New York (Empire), Philadelphia, Kansas City, Dallas, Chicago and Philly – show economic contraction in manufacturing. Does the 30% of our economy that represents the beleaguered manufacturing segment no longer matter? Is the 70% consumer so resilient that he/she can overcome a global slowdown, a stagnant domestic manufacturing segment and a domestic revenue recession? Investors who do not want to pay attention to the technical, fundamental or macro-economic warning signs may wish to pay attention the micro-economic, corporate sales erosion. As Peter Griffin of the Family Guy Sitcom might say, “Oh, did you not hear the word?” Simply stated, the expected revenue for the S&P 500 for the third quarter is headed for a third straight quarterly decline at 3.3%; the 4th quarter should show a 1.4% decline to make it four in a row. The Dow Industrials? They’ve experienced lower sales for even more consecutive quarters. Beware, perma-bulls would like to blame this all on the energy sector. Should we then ignore the ongoing declines in industrials, materials, utilities, info tech ex Apple? If we strip out energy, do we get to strip out the over-sized contribution of revenue gains by the health care sector? There’s an old saying that goes, “You can’t making chicken salad out of chicken caca.” Here’s the bottom line. Moderate growth/income investors who have been emulating my tactical asset allocation at Pacific Park Financial, Inc., understand why we will continue to maintain our lower risk profile of 50% equity (mostly large-cap domestic), 25% bond (mostly investment grade) and 25% cash/cash equivalents. We are leaving in place the lower-than-typical profile for moderates that we put in place during the June-July period. When market internals improve alongside fundamentals, we would look to return to the target allocation for moderate growth/income of 65%-70% stock (e.g., large, small, foreign, domestic) and 30% income (e.g., investment grade, high yield, short, long, etc.). For now, though, we are comfortable with lower risk equity holdings. Some of those holdings include the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ), the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) , the iShares Russell Mid-Cap Value ETF (NYSEARCA: IWS ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ).

Active Power: An Analyst Catalyst Candidate?

ACPW reported an impressive Q2 which put the finishing touches on a further impressive 1H. The analyst community has taken notice. With changing estimate trend lines is ACPW an Analyst Catalyst candidate? Seeking Alpha readers who follow my writings understand just how lucrative identifying this can be. It looks like analysts are beginning to see a good story and a story in which they are collectively getting more and more confident in when it comes to Active Power (NASDAQ: ACPW ). After the company’s Q2/15 reporting confirmed what is shaping up to be an inflection point for operations analysts have come to modeling Active Power more bullish than prior and, importantly, more bullish in trend than prior. This matters in a big, big way for getting some volume into the name and for getting some valuation multiple expansion. I detailed the Active Power quarter reported in an initiation note in which I concluded the same as apparently what is now becoming a very consensus analyst opinion -Active Power is finally on its way to healthier income statement performances. Still, to see analysts turn estimate trends positive is encouraging and could, with a quarter or two of further execution, turn into the phenomenon I’ve called the Analyst Catalyst. I’ve detailed this before for Seeking Alpha readers in other names near inflection points of several varieties (growth rates, cash flow positive, EBITDA positive, etc.). It’s been a long, long time since Active Power was the recipient of such faith from the markets and that is reflected in its share price. A change would be welcomed by shareholders and is something that shareholders should pay close attention to. Active Power is currently modeled for steady increases to revenue, EBITDA, and fully diluted EPS to end full year 2015. Through 1H/15 the company remains well on pace to hit these marks. These would be higher highs put in for the noted metrics after the company bottomed in each category in full year 2014. Full year 2014 marked Active Power’s third consecutive year of posting lower lows for the line items – something that drove its stock price lower, investor sentiment to all-time lows, and analyst faith to a point of non-existence. Obviously the modeling change to growth in these categories for full year 2015 and for full year 2016 speaks to the turnaround at the company in progress: You can see in the table above that Active Power is expected to achieve the all-important EBITDA breakeven at full year 2015 reporting with the company going on to report its first EBITDA positive year in four years at full year 2016 reporting. That will be a huge milestone for the company and one that I think will open the name up to significant investment from institutions and other asset managers that can’t or choose not to invest in non-EBITDA positive names. This is more common than most understand. Also, it’s excellent to see that Active Power is modeled to reach near breakeven for EPS in full year 2016 reporting. Again though, maybe the best part of all this is that Active Power has now established positive estimate trends across these categories. In beating estimates, Active Power has essentially validated the reporting analysts’ models – which makes them look smart, which they like. As a natural consequence of both, analysts have had to positively revise estimates at each quarter reported based on the previous beat. I believe these positive revisions, which take place early to mid-quarter, help propel volume and upward share price movement between quarterly reporting. This cumulative effect of analysts powering shares higher at early or mid-quarter AND company quarterly reporting powering shares higher works to create a constant cycle of volume and higher pricing. In general I refer to this as the Analyst Catalyst. You can see in the charts below Active Power might be on the brink of such a bullish cycle: (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) I believe that we should see a continued Analyst Catalyst take shape at Active Power as the company continues to impress at quarterly reporting. Active Power is showing excellent trend lines for income statement line items and for key metrics reported as a result of its maturing sales team (which the cumulative effect of this is hard to model) and its growing more well-known value prop. Both should make sure that Active Power continues in its turnaround success and in reshaping its total income statement. I’ll provide updates as I see estimates positively or negatively revise. Good luck everybody. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.