(Idea) Why I Bought Arc Resources
Editor’s Note: Jon Costello, head of “Ideas from HFI Research”, made a call to sell out of his EQT position and go long Arc Resources. This is his detailed write-up on why he chose Arc over EQT.
By: Jon Costello
Note: Dollar references are to Canadian dollars unless otherwise specified.
Arc Resources (ARX:CA) (OTCPK:AETUF) is one of the premier North American E&Ps. The company offers a rare combination of low-cost production, a strong balance sheet, steady production growth, a balanced production mix, and an outstanding marketing operation.
ARC is on the cusp of completing a major expansion project. We expect production growth and the cash flow growth it creates over the next year to be a catalyst for a higher stock price.
Why We Switched to ARC from EQT
Compared with EQT (EQT), ARC offers a stronger balance sheet, which reduces downside risk to shareholders when prices are low. Its realized pricing is also superior, and its reserve life is considerably longer than that of EQT.
Aside from its attractive attributes—covered below—nearly all of which are superior to EQT, I particularly like that ARC intends to grow cash flow through production growth. EQT, by contrast, offers limited production growth and, as such, will grow cash flows through higher natural gas prices.
EQT’s dependence on volatile natural gas prices represents a sort of wild card in its valuation. While it could bring a bonanza to shareholders if gas prices are sustained at high levels, it could also bring losses if gas prices remain low. As I mentioned in my article yesterday, we expect gas prices to fluctuate widely as demand increases, prices increase, supply then increases to satisfy demand, and prices fall back down.
I don’t have any insight into the timing of these elongated pricing waves, but they complicate the timing of stock purchases and sales in E&Ps that lack production growth. I know from experience that it’s easy for even the most seasoned energy investors to get caught up in the bullish momentum that comes with rising commodity prices. The psychology of the situation increases the risk that an investor misses the optimal time to sell and rides the shares right back down to where they were before the rally. (Ahem, been there too many times…)
With a steady grower like ARC, investors can hold through multiple commodity cycles and be confident that value will be created over the long term.