Southwestern Energy Co. (SWN) has reported fourth-quarter 2011 earnings of 45 cents per share, which came in below the Zacks Consensus Estimate of 48 cents. However, the quarterly results showed a 4.7% improvement from the year-earlier profit of 43 cents.

Fiscal 2011 earnings showed an improvement of 5.2% year over year to $1.82 per share from $1.73 in the prior year. However, full-year earnings missed the Zacks Consensus Estimate of $1.85.

The year-over-year improvement was backed by production growth, primarily at its Fayetteville shale operations.

Fourth-quarter revenue climbed approximately 11% to $744.2 million from the year-ago level of $670.4 million. The revenue lagged the Zacks Consensus Estimate of $771 million.

Fiscal 2011 revenue was $2,952.9 million, up 13.1% year over year. The annual revenue came in below the Zacks Consensus Estimate of $2,987.

Production and Realized Prices

For full-year 2011, Southwestern’s oil and gas production was 500 billion cubic feet equivalent (Bcfe), up 23.5% from 404.7 Bcfe in the prior year.

During the reported quarter, the company’s oil and gas production shot up nearly 20% year over year to 133.3 Bcfe, driven by the Fayetteville Shale operations. Production from Southwestern’s Fayetteville Shale play increased 18% to 116.5 Bcfe from the year-earlier period.

The company’s average realized gas price, including hedges, dropped nearly 7% to $4.04 per thousand cubic feet (Mcf) from $4.33 per Mcf in the year-ago period. Oil was sold at $96.49 per barrel, up 16.7% from the year-earlier level of $82.70 per barrel.

Segmental Highlights

Operating income from the Exploration and Production (E&P) segment dropped 2.1% to $195.8 million in the fourth quarter. The slight decrease was due to lower gas price realization as well as increased operating costs and expenses related to higher production, which was partially toned down by the increased production level.

On a per-Mcfe basis, lease operating expenses were marginally up at 84 cents from 83 cents in the prior year. On the other hand, general and administrative expense per unit of production dropped 10% year over year to 27 cents.

The Midstream Services segment’s operating income leaped more than 19% to $67.6 million in the fourth quarter from $56.8 million in the year-earlier quarter. The increase was driven by an improvement in gathering revenues related to the Fayetteville and Marcellus Shale plays.

Capex and Debt

The company’s total capital expenditure in the quarter was $650.2 million, of which $612.1 million was invested in E&P activities and $22.8 million in the Midstream segment.

As of December 31, 2011, long-term debt stood at $1,342.1 million, representing a debt-to-capitalization ratio of 25.3% (versus 26% in the preceding quarter).

Hedging

At February 27, 2012, Southwestern had approximately 266 Bcf and 185 Bcf of its 2012 and 2013 expected gas productions hedged at an average floor price of $5.16 and 5.06 per Mcf, respectively.

Guidance

Due to a reduction in its previously planned capital investments, Southwestern has updated its production guidance for 2012. The revised total gas and oil production guidance for 2012 is 560 Bcfe to 570 Bcfe. The updated outlook represents a 13% increase over the 2011 level. The company has also revised its first quarter 2012 oil and gas production estimate to 132-134 Bcfe from 134-136 Bcfe.

Of the company’s total expected production for 2012, approximately 465 Bcf to 470 Bcf is expected to come from the Fayetteville Shale and approximately 60 Bcf to 65 Bcf is expected to come from the Marcellus Shale.

Our Take

Southwestern’s industry-leading holdings in Northern Arkansas’ Fayetteville Shale play make it one of the highest quality natural gas discoveries in North America in the recent years. In 2012, the company expects to invest approximately $1.1 billion and $526 million in the Fayetteville Shale and Marcellus Shale, respectively. Marcellus and Fayetteville shales also hold ample opportunities for newer natural gas discoveries.

We see the company as well positioned for production growth given its streamlined cost structure, upcoming drilling programs in the Fayetteville and Marcellus shales and a wide acreage in its New Ventures. During 2011, Southwestern’s Marcellus shale operations in northeastern U.S. produced 23.4 Bcf, compared with 1 Bcf produced in the prior year.

However, we remain apprehensive regarding the weak natural gas scenario in the U.S. arising out of continued oversupply and low demand for natural gas. This will likely impede the company’s performance in the near term.

Other risk factors include weaker-than-expected commodity prices, technological failures and the lack of a diversified asset base. Competition from its peers, such as Chesapeake Energy Corporation (CHK), also remains a cause for concern.

The company holds a Zacks #5 Rank (short-term Strong Sell rating). We also maintain our long-term Neutral recommendation on the stock.

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