Natural gas producer and pipeline firm Williams Companies (WMB) reported weaker-than-expected second-quarter 2010 results, as the company’s decision to curtail drilling activity led to lower volumes.

Earnings per share, excluding special items, came in at 27 cents, below the Zacks Consensus Estimate of 30 cents.

However, revenue of $2.3 billion was ahead of our expectations at $2.1 billion amid higher sales across all the units.

Year-over-Year Results Improve

Comparisons with the year-earlier period were favorable, reflecting significant improvement in Williams Partners’ results. Williams’ adjusted earnings per share jumped approximately 35.0% (from 20 cents to 27 cents), while revenues increased 20.1% (from $1.9 billion to $2.3 billion).

E&P

In the E&P business, total production was down approximately 5.3% year over year to 1,168 million cubic feet equivalent per day (MMcfe/d). Domestic volumes decreased 5.9% year over year to 1,110 MMcfe/d, reflecting the company’s decision to curtail drilling during the recent recessionary period of low prices. For the second quarter of 2010, average daily net production from the Piceance, Powder River and other basins were down approximately 7%, 6% and 2%, respectively, from the year-ago level.

However, a 10.4% increase in Williams’ domestic average realized natural gas price (from $3.949 per thousand cubic feet equivalent (Mcfe) to $4.359 per Mcfe) helped the company to somewhat offset the lower production volumes.

Segment operating profit was down 23.7% year over year to $87 million in the second quarter of 2010.

Williams Partners

This segment reported an operating profit of $346 million, up from the year-ago level of $285 million, primarily due to higher natural gas liquid (NGL) margins from Williams Partners’ midstream business. NGL prices were considerably higher in the quarter under review, against unusually low recession-driven second quarter 2009 prices. This benefit was somewhat offset by an increase in costs due to higher average natural gas prices.

Other

Segment operating profit was $79 million, against $6 million in the year-ago period. This year-over-year improvement can be attributed to higher production margins from NGL and olefins, somewhat offset by lower olefin production volumes.

Capital Expenditure & Balance Sheet

During the quarter, Williams spent $512 million on capital expenditure, up from $465 million last year. As of June 30, 2010, the company had debt of $8.5 billion, representing debt-to-capitalization ratio of 52.7%. Williams has a current cash balance of about $1.6 billion.

Guidance

Management guided towards full-year 2010 earnings of $1.00 – $1.45 per share, while 2011 is likely to be between $1.15 and $2.50. Capital expenditure during 2010 is expected to be around $3.5 – $4.0 billion. Williams hopes to spend between $2.4 billion and $3.7 billion in 2011.

Our Recommendation

We like Williams’ strong business mix, attractive growth opportunities in its low-risk upstream model and relatively stable fee-based midstream services. We also think that the recently-concluded consolidation program will allow Williams to simplify its structure, pay down debt, drive growth and unlock value for shareholders. Furthermore, the company’s impressive exposure to the high-return Marcellus Shale play is expected to be long-term accretive.

However, Williams’ leveraged balance sheet and exposure to volatility in natural gas and natural gas liquids prices offset these strengths and remain key areas of concern, in our view. As such, we see limited upside from current levels and rate Williams as Neutral.

 
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