Comstock Resources: Dealing With Significantly Negative Near-Term Free Cash Flow

Comstock Resources (NYSE:CRK) reported significantly negative free cash flow in Q2 2023, driven by weak natural gas prices. Comstock realized $1.81 per Mcf (before hedges) for its natural gas during the quarter, and $2.25 per Mcf after hedges. This resulted in a $183 million free cash flow deficit from operations (not including the effect of working capital changes) during the quarter.

If Comstock maintains its dividend, I expect it to have $203 million in cash burn during the second half of the year, including the impact of $69 million in dividend payments.

For 2024, Comstock may end up at roughly breakeven cash flow after dividends at current strip of $3.50 NYMEX gas while delivering modest production growth.

Based on a long-term $3.75 NYMEX natural gas price, I now estimate Comstock's value at approximately $12.50 per share. This is reduced from my previous estimates due to weak near-term free cash flow expectations and a change from $4.00 to $3.75 for the long-term natural gas price that I use.

Production And Capex

Comstock produced an average of 1,389 MMCFE per day in Q2 2023, down 2% compared to its 1,414 MMCFE per day in Q1 2023 production. Comstock's Q2 2023 production was also 1% below the midpoint of its guidance range for 1,375 to 1,435 MMCFE per day in Q2 2023 production.

Comstock also reported $329 million in total capex for Q2 2023, which was a bit above the $313 million midpoint of its guidance for $278 million to $348 million in total capex for the quarter.

Based on Comstock's guidance for 1,350 to 1,450 MMCFE per day in production for Q3 2023, it seems likely to end up at around the low-end of its (unchanged) full-year guidance for 1,425 to 1,550 MMCFE per day in average production.

If Comstock hits the midpoint of its Q3 2023 guidance, it will have averaged 1,401 MMCFE per day after the first three quarters of 2023. It would then need significant sequential growth to 1,496 MMCFE per day in Q4 2023 to end up at 1,425 MMCFE per day for the full year, which is at the low end of its guidance range.

On the positive side for Comstock, its D&C costs per lateral foot have stabilized after rising sharply over the last couple years. Comstock's Q2 2023 D&C costs of $1,523 per lateral foot are 4% lower than in Q1 2023, although still 15% higher than in 2022, when natural gas prices were much higher than current levels.

Free Cash Flow

Comstock realized $2.40 per Mcf for its natural gas before hedges during the first half of 2023, including only $1.81 per Mcf during Q2 2023. It realized $0.29 per Mcf less than NYMEX for its natural gas in Q2 2023. Natural gas accounts for 99.9% of Comstock's total production.

For Q2 2023, Comstock also realized $55.5 million in hedging gains, helping bring its realized price for natural gas up to $2.25 per Mcf after hedges.

The low natural gas prices resulted in a large free cash flow deficit (excluding changes in working capital) for Comstock in the quarter. Comstock reported $145 million in operating cash flow before working capital changes, compared to $329 million in capital expenditures. Thus Comstock had a $183 million free cash flow deficit from operations (by its definition) in Q2 2023.

Working capital changes benefited Comstock's cash flow by $186 million during Q2 2023, while it also received $25 million in net proceeds from divestitures (less acquisitions). This prevented Comstock's net debt (not including its working capital deficit) from surging during the quarter, although its working capital deficit is quite substantial at around $480 million at the end of Q2 2023.

2H 2023 Outlook

I am modeling Comstock's 2H 2023 production at an average of 1,450 MMCFE per day. This would get it to slightly above the low end of its full-year guidance.

At that production level and current 2H 2023 strip of $2.90 NYMEX gas (along with a negative $0.25 differential), Comstock is projected to generate $734 million in revenues after hedges.

Comstock's capex budget (including acreage leasing) may be around $570 million over the second half of 2023. It is projected to generate negative $134 million in free cash flow over this period before working capital changes or dividends.

After factoring in Comstock's current $0.125 per share quarterly dividend, it would have around $203 million in projected cash burn during the second half of 2023 before any working capital changes.

Potential 2024 Outlook

For 2024, I am assuming that Comstock can generate roughly 2% production growth for $1 billion in total capex. This would allow it to average around 1,450 MMCFE per day in production for the full year.

At current 2024 strip of $3.50 NYMEX gas, Comstock would generate $1.742 billion in revenues after hedges if its differential is negative $0.25.

Comstock has hedges covering 130 MMCF per day in 2024 natural gas production at an average price of $3.50, so those hedges have neutral value in this scenario.

Comstock is thus projected to generate $134 million in free cash flow in 2024 before dividends. After factoring in dividend payments, it would end up with $5 million in cash burn.

Estimated Valuation

I've changed the long-term natural gas price that I use in my models to $3.75 NYMEX gas, down from $4.00 NYMEX gas earlier in the year. In a long-term $3.75 NYMEX gas environment, I'd estimated Comstock's value at approximately $12.50 per share. At long-term $4.00 NYMEX gas, I'd value Comstock at approximately $14.50 per share.

Comstock's debt reduction efforts are hampered by its dividend and cash interest payments, which add up to approximately $300 million per year, or approaching $0.60 per Mcfe.

Jerry Jones will likely want Comstock to maintain its dividend since he converted his preferred stock into common shares last year. It can probably maintain its dividend if natural gas is at $3.50+ next year, but lower natural gas prices may threaten the dividend.

Conclusion

Comstock is dealing with a period of significantly negative free cash flow due to low natural gas prices. At $3.50 NYMEX in 2024, it can likely reach around breakeven free cash flow while maintaining its dividend. For 2023 though, it may end up with close to a $400 million free cash flow deficit from operations (which includes the impact of capex), before working capital changes.

Comstock's financial position is strong enough to handle the negative free cash flow in 2023, but it may need to consider reducing or eliminating its dividend if natural gas prices end up averaging noticeably below $3.50 in 2024.

I estimate Comstock's value at approximately $12.50 in a long-term $3.75 NYMEX scenario, and thus am neutral on it currently.

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