Southwestern Energy: Free Cash Flow Generation Set To Improve
Summary
- Southwestern's near-term free cash flow has been limited due to weak natural gas prices.
- The strip for 2024 and 2025 is now around $3.50 and $4.00 respectively.
- At those prices, Southwestern could generate $2.4 billion in free cash flow over that two year period.
- Southwestern does have a significant amount of debt, but the bond markets are not very concerned about its ability to deal with its debt.
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Southwestern Energy's (NYSE:SWN) near-term cash flow has been limited by weak natural gas prices, but with NYMEX gas strip currently at around $3.50 for 2024 and $4.00 for 2025, its longer-term outlook looks brighter.
Southwestern does have a substantial amount of debt, with around $4 billion in net debt currently, along with current payables that exceed current receivables by close to $1 billion. However, it also looks capable of generating around $1 billion in combined free cash flow in 2H 2023 and 2024 (mostly weighted to 2024). The debt markets also view Southwestern relatively favorably, as its unsecured notes due 2032 are still yielding under 7% to maturity.
I estimate Southwestern's value at approximately $8 per share using my long-term commodity price estimates of $75 WTI oil and $3.75 NYMEX gas.
2H 2023 Outlook
Southwestern expects production to be roughly flat with Q2 2023 levels in Q3 2023 before declining a bit (around 3%) to approximately 4.5 Bcfe per day in Q4 2023. Southwestern's 2023 capital expenditure budget was front-loaded to the first half of the year, and it also has reduced its capex guidance by 10% (partly due to activity reductions).
At current strip of approximately $2.85 NYMEX gas for the second half of 2023, Southwestern may be able to generate $2.04 billion in revenues, inclusive of basis hedges, but excluding its other hedges (which have another $118 million in estimated value).
| Barrels/Mcf | Per Barrel/Mcf | $ Million | |
| Natural Gas | 727,000,000 | $2.05 (including impact of basis hedges and transportation costs) | $1,490 |
| NGLs | 16,540,000 | $22.00 | $364 |
| Oil | 2,860,000 | $65.00 | $186 |
| Hedge Value | $118 | ||
| Total | $2,158 |
With the reduced capex budget, Southwestern may spend approximately $800 million in D&C, land and other capex in the second half of the year.
| $ Million | |
| Lease Operating Expenses | $902 |
| Production Taxes | $143 |
| G&A | $76 |
| Cash Interest | $115 |
| Capital Expenditures | $800 |
| Total | $2,036 |
This leads to a projection of $122 million in free cash flow during the second half of 2023.
Potential 2024 Outlook
I've attempted to model Southwestern's results for 2024 based on a scenario where it keeps production flat versus Q4 2023 levels at approximately 4.5 Bcfe per day.
At the current 2024 strip of approximately $3.50 NYMEX gas (and $76 WTI oil), Southwestern is then projected to generate $5.143 billion in oil and gas revenues, inclusive of its hedges.
| Barrels/Mcf | Per Barrel/Mcf | $ Million | |
| Natural Gas | 1,418,000,000 | $2.85 (including impact of basis hedges and transportation costs) | $4,041 |
| NGLs | 31,800,000 | $23.25 | $739 |
| Oil | 5,600,000 | $62.00 | $347 |
| Hedge Value | $16 | ||
| Total | $5,143 |
I've estimated that Southwestern can maintain production at 4.5 Bcfe per day with $1.8 billion in D&C, land and other capex. This is around 7.5% less than its full-year 2023 budget for those items and 12.5% higher than its 2H 2023 run rate capex.
| $ Million | |
| Lease Operating Expenses | $1,757 |
| Production Taxes | $333 |
| G&A | $152 |
| Cash Interest | $215 |
| Capital Expenditures | $1,800 |
| Total | $4,257 |
Southwestern is thus projected to generate $886 million in free cash flow in 2024 at $3.50 NYMEX gas and maintenance capex. This doesn't include the potential impact of cash income taxes and doesn't include the potential impact of changes in working capital.
Debt Situation
Southwestern had slightly over $4 billion in net debt at the end of Q2 2023. Its projected 2H 2023 free cash flow would reduce its net debt to approximately $3.9 billion by the end of 2023, and its projected 2024 free cash flow (based on the scenario mentioned above) would reduce its net debt to $3.02 billion by the end of 2024. This would be within Southwestern's debt target of $3.0 billion to $3.5 billion. One thing to note is that working capital changes could affect Southwestern's debt reduction efforts, as its receivables were nearly $1 billion less than its payables at the end of Q2, 2023.
Despite currently having $4 billion in net debt, the debt markets view Southwestern's debt situation as being pretty manageable, with its unsecured notes due 2032 yielding under 7.0% to maturity.
Notes On Valuation
Southwestern may be able to generate approximately $1.2 billion in free cash flow per year (before cash income taxes) at long-term commodity prices of $75 WTI oil and $3.75 NYMEX gas. This also assumes that it maintains production at around 4.5 Bcfe per day.
At those long-term commodity prices, I estimate Southwestern's value at approximately $8 per share now. Southwestern's free cash flow yield (with $1.2 billion in free cash flow) in this scenario would be approximately 13.6%.
Southwestern's free cash flow yield (with interest costs added back in) based on its enterprise value and factoring in its working capital deficit would be around 10.3% instead.
I believe that free cash flow yield is reasonable as even with full cash income taxes, that yield would be higher than the yield to maturity on Southwestern's bonds.
Conclusion
Southwestern's near-term free cash flow generation is relatively limited, but it appears capable of generating (before cash income taxes) close to $900 million free cash flow in 2024 and around $1.5 billion free cash flow in 2025 at current strip prices.
This should allow it to reduce its debt to its targeted levels, which would also likely involve repaying its $389 million in 4.95% unsecured notes due January 2025 via free cash flow. Southwestern is capable of refinancing these notes too, but would likely pay around 2% higher interest rates if it attempted to refinance those notes.
Based on my long-term commodity price estimates of $75 WTI oil and $3.75 NYMEX gas, I estimate Southwestern's value at $8 per share.
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