We've raised our fair value estimate for Range to $20 per share from $18, after incorporating the firm's fourth-quarter financial and operating results. The increase reflects slightly less growth than we were previously modeling (Range is aiming to keep volumes flat this upcoming year), but with better margins. We were extrapolating higher gathering, transport and processing fees from the middle of last year, but the firm reported lower unit costs in the fourth quarter and management expects the improvement to persist in 2023. We have also captured further deterioration in near term natural gas prices and raised our cost of capital estimate to the higher equity mix in the capital structure. Shares still look slightly overvalued after the increase in our valuation.

Shares advanced 4% on the first trading day after the results were announced, amid a broader selloff for upstream producers. As we previously highlighted, the firm's fourth-quarter performance was ostensibly disappointing when compared with previous guidance, but the bad news was well telegraphed by management at the end of the prior quarter. Full-year production came in at the lower end of the guidance range, as management suggested. Capital spending slightly exceeded the top end of the guidance range, where it was expected to land, based on third-quarter commentary. But the good news was fresh. Transportation, gathering, processing, and compression fees were lower than expected, and lower than we were previously projecting. Therefore, the firm's financial results were still slightly better than the market was expecting, with adjusted earnings per share in the fourth quarter coming in at $1.30 per share (the FactSet consensus estimate for the same was $1.18 per share). The capital budget was set at $570 million-$615 million (20% higher year on year, which is again consistent with prior signaling from the company and also about average for the upstream space).

Range Resources is an exploration and production firm focusing on the Marcellus Shale play in southwest Pennsylvania. Natural gas accounts for over two thirds of its production, but a portion of its acreage also yields natural gas liquids, which gives it indirect exposure to crude prices (NGLs are substitutes for certain refined oil products). Management can easily shift capital between the liquids-rich and dry gas portions of its acreage as commodity prices fluctuate.

Range was a first mover in the Marcellus Shale, which has been a major component of the U.S. natural gas supply stack since 2010. It has assembled close to half a million net acres in the southwest Pennsylvania core of the play, giving it a huge advantage over other Appalachia producers. Data from Rystad Energy fully supports management's oft-repeated claim that it has a longer inventory life than its peers. Most will use up their best acreage in the next 5-10 years, forcing them to pivot to areas where well performance is typically weaker and supply costs are commensurately higher. Not so for Range, which could maintain its current cadence for much longer without having to worry about exhausting its core resources.

Appalachia producers have had to contend with huge swings in commodity prices in the last few years. The shale revolution delivered a tidal wave of low cost supply that left the domestic natural gas market saturated for the better part of the last decade. This was exacerbated by periodic pipeline shortages in the region that pushed out basis differentials and further eroded revenue for upstream firms. But that regime is almost over. In 2024, a further surge in liquefied natural gas and NGL export capacity, coupled with durable global demand growth for Range's dry gas and liquids products, is the backbone of our more favorable long-term outlook. Acreage and infrastructure constraints will chronically limit supply growth in the Haynesville and Marcellus gas plays, forcing producers to look higher on the cost curve to balance the market. Firms with ample drilling inventory and marketing agreements for flow assurance, like Range, will benefit from continued higher pricing.

The ability to generate durable excess returns on invested capital is a hallmark of companies with economic moats. Range has historically struggled to do so, and though it is likely to earn its cost of capital in the near term, this is due to transient factors including above-midcycle crude prices and net operating loss carryforwards that temporarily shield Range from federal taxes. We assign a no-moat rating.

The firm's Marcellus Shale acreage does generate solid field-level returns under midcycle conditions (with West Texas Intermediate averaging $55 a barrel and Henry Hub $3.30 per thousand cubic feet). And with over 3,000 potential drilling locations in its inventory, the firm has a genuinely long runway in the play, differentiating it from most of its gas-focused E&P peers. But after incorporating costs sunk on leasehold, acquisitions, exploration, and infrastructure, Range's capital base inflates to a level that makes high returns on capital very difficult.

For Range, the most significant environmental, social, and governance exposure is greenhouse gas emissions (both from extraction operations and downstream consumption). Greenhouse gas emissions are unavoidable for oil and natural gas producers. Firms can clean up their operations in the field as much as possible by avoiding unnecessary flaring and using technologies like electric fracking and carbon capture to reduce carbon dioxide volumes being released into the atmosphere during the extraction process. Range has reported statistics showing a strong improvement in this area (as have peers). For example, it lowered its overall greenhouse gas intensity by 80% between 2011 and 2020 and is targeting a further 15% reduction by 2025. By combining this with carbon offsets (reforestation and forest management), it aims to reach net zero the same year.

But because downstream emissions are beyond producers' control, there's really no such thing as a "clean" E&P company. Natural gas is primarily used for electric power generation and for commercial and residential heating. As consumers get more averse to fossil fuels, the reputational risk grows for producers and the probability of widespread substitution away from fossil fuels increases. We believe renewable energy will continue to gain share over fossil fuels in the next few years but at the expense of coal rather than natural gas (which is less carbon-intense than coal but does not have the intermittency issues that plague wind and solar generators). Nevertheless, there is still the potential for value-destructive regulatory intervention (think fracking restrictions or carbon taxes). These threats are not likely enough to be included in our base forecasts, but the impact is potentially material.

Our primary valuation tool is our net asset value forecast. This bottom-up model projects cash flows from future drilling on a single-well basis and aggregates across the company's inventory, discounting at the corporate weighted average cost of capital. Cash flows from current (base) production are included with a hyperbolic decline rate assumption. Our valuation also includes the mark-to-market present value of the company’s hedging program. We assume oil (WTI) prices in 2023 and 2024 will average $80/bbl and $71/bbl, respectively. In the same periods, natural gas (Henry Hub) prices are expected to average $3.10/mcf and $3.70/mcf. Terminal prices are defined by our long-term midcycle price estimates (currently $60/bbl Brent, $55/bbl WTI, and $3.30/mcf natural gas).

Based on this methodology, our fair value estimate is $20 per share. This corresponds to enterprise value/EBITDA multiples of 3.8 times and 3.9 times for 2023 and 2024, respectively. Our production forecast for 2022 is 2,177 thousand cubic feet of natural gas equivalent per day, which is a bit below guidance from management. That drives 2023 EBITDA to $1.3 billion, and we expect cash flow per share to reach $5.15 in the same period. Our 2024 estimates for production, EBITDA, and cash flow per share are approximately 2,231 mmcfe/d, $1.6 billion, and $6.06, respectively.

Our Morningstar Uncertainty Rating is High, due to the volatility of oil, natural gas, and NGL prices.

As with most E&P firms, a deteriorating outlook for oil and natural gas prices would pressure Range’s profitability, reduce cash flows, and drive up financial leverage. Other risks to keep an eye on include regulatory headwinds (most notably environmental concerns) and uncertainty about future federal tax policy. More specific to Range, the flip side of having a large inventory of potential drilling opportunities is that demand for the product could have evaporated by the firm gets around to drilling it.

In this industry, greenhouse gas emissions are the most significant concern (both from extraction operations and downstream consumption) along with other emissions, effluents, and waste (primarily oil spills). In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as fracking bans, and drilling permit suspensions. One example of a long-term potential impact would be a switch to renewable hydrogen using wind and solar as sources for power generation compared with hydrogen generated primarily from natural gas.

We assign Range a Standard capital allocation rating.

The firm has historically carried too much financial leverage, making it more vulnerable to declines in commodity prices. That was also true for peers, to an extent, but Range was slower than most to strengthen its balance sheet. Its leverage ratios finally reached a comfortable level in the back half of 2021, and further deterioration is very unlikely, given the firm's solid free cash generating profile.

Capital allocation has much improved. Like peers, the firm has fully embraced capital discipline and has no intention of recklessly increasing its production. For the time being, the firm is targeting a maintenance-like capital program, with low-single-digit volume growth at the most, regardless of how high spot prices get for natural gas and NGLs. Management has hinted that it is willing to step up its activity modestly if the futures curves are attractive enough, but only after other priorities—like further deleveraging and funding competitive capital returns—have been taken care of. Range is a low-cost producer with a lengthy runway of attractive drilling opportunities, and it would be prudent to target modest growth down the road, as long as it can do so without meaningfully increasing its reinvestment rate or compromising its robust free cash stream.

Range cut its dividend to zero in 2019, during a challenging period of high leverage and low commodity prices. This was absolutely the right approach, as it left the firm with more flexibility for debt repayment. But once its balance sheet issues were resolved, Range was able to reinstate the dividend and prioritize incremental capital returns, like most peers are doing. The firm repurchased $400 million of stock in 2022 and paid $39 million in dividends.