SM SM Energy Company

Denver-based Forest Oil Corporation’s (FST) fourth quarter 2011 earnings from continuing operations of 18 cents per share (excluding non-recurring items) missed the Zacks Consensus Estimate of 26 cents and the year-earlier number of 41 cents.

The lackluster performance was mainly due to the lower prices realized for natural gas as well as natural gas liquids (NGLs) and decline in net sales volumes, which were partially offset by the higher oil price.

Total revenue in the reported quarter was down at $176.7 million from the year-ago level of $179.2 million, and came nowhere near the Zacks Consensus Estimate of $188 million.

Operational Performance

Net sales volumes shrunk 12% year over year to 341.6 million cubic feet equivalent per day (MMcfe/d) in the reported quarter, mainly due to production downtime in the Texas Panhandle associated with third party infrastructure issues. However, the company has been able to raise its liquid proportion of production, which comprises 30% of total production versus 27% in the third quarter of 2011.

The average equivalent price per Mcf (including the effect of hedging) was $6.13, up from the year-ago realization of $5.73. Average realized natural gas price was $4.41 per Mcf, down 3.5% from the comparable prior-year quarter, and natural gas liquids (NGLs) were sold at $31.25 per barrel, down 17.6% from third quarter 2010. However, average realized oil price was $93.93 per barrel, up 24.56% from the year-ago quarter.

During the quarter, production expenses increased 31.6% year over year to $1.29 per Mcfe. Unit general and administrative expenses increased 31% year over year to 38 cents per Mcfe. Depreciation and depletion expenses per unit increased 36% to $2.05 per Mcfe from $1.51 per Mcfe in the corresponding 2010 quarter.

Financials

At quarter end, Forest had $3.0 million of cash and cash equivalents with $1,693.0 million of long-term debt, representing a debt-to-capitalization ratio of 58.7% (up from 61.4% at the end of third quarter 2011).

Lone Pine Spin-off

During 2011, the company completed the spin-off of Lone Pine Resources Inc. (LPR). Subsequent to the initial public offering of Lone Pine on June 1, 2011, Forest owned approximately 82% of the outstanding shares of Lone Pine's common stock.

On September 30, 2011, Forest distributed, or spun off its remaining ownership in Lone Pine in the form of a pro rata common stock dividend to all Forest shareholders of record as of the close of business on September 16, 2011 (the Record Date). Forest shareholders received 0.61248511 of a share of Lone Pine common stock for every share of Forest common stock held as of the close of business on the record date.

Outlook

We like Forest Oil’s initiatives toward increased liquids production. The company’s focus on cost control and the upside from Granite Wash and the Missourian Wash interval position it well to weather the weakness in natural gas prices.

The company’s drilling results from its new Texas Panhandle oil zones and the Granite Wash "A" zone were well above its expectations, demonstrating strong hydrocarbon potential in the Texas Panhandle from 'new' zones. Except the success achieved in the Missourian Wash and Cleveland oil zones, the company also achieved success in the new oil zone, with an 80% working interest, located outside of Wheeler and Hemphill Counties.

However, with natural gas accounting for almost 70% of the total production in the fourth quarter of 2011, Forest Oil is exposed to the tentative outlook of the North American natural gas market. Its operations and cash flow are more sensitive to fluctuations in the market price for natural gas than to fluctuations in the market price for oil and NGLs.

Forest faces tough competition from its peer such as SM Energy Company (SM), which reported better-than-expected fourth quarter 2011 results. Consequently, we maintain our long-term Neutral recommendation for the stock. Forest Oil also holds a Zacks #3 Rank (short-term Hold rating).

 
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