We're starting a position in this energy stock, drawn to its valuation and natural gas exposure

Published Thu, Apr 14 20222:52 PM EDTUpdated Thu, Apr 14 20226:47 PM EDT

We are initiating a position in Coterra Energy (CTRA), buying 800 shares at roughly $29.05. Following the trade, the Charitable Trust will own 800 shares of the energy company, making it a 0.7% weighting in the portfolio. For some background, Coterra Energy is the newly formed company that was renamed after Cabot and Cimarex joined forces in an all-stock merger last year. This was a true marriage of equals, with Tom Jorden, the CEO of Cimarex, taking over as the CEO of the combined company and Dan Dinges, the CEO of Cabot, taking the executive chairman spot. The market didn't initially seem to love this deal. Shares of both Cimarex and Cabot got hit on the news and then slid steadily over the following months. What the market couldn't quite get a handle on was why a natural gas producer focused on the Marcellus Shale like Cabot would join forces with a Southwestern oil company like Cimarex. But the value proposition was always there. At the time of the deal announcement, management highlighted its ability to generate cash and return it back to shareholders through a base-plus-variable dividend that is based on free cash flow. Plus, the all-stock merger of equals means no debt was used to fuel the acquisition, keeping the balance sheet clean. Although the deal wasn't loved at first, higher oil and natural gas prices have quickly changed the fortunes of a lot of companies. Perhaps most importantly, Coterra is operating under the same discipline that we have seen from Devon Energy (DVN) and the other publicly traded producers. Remember, back in the old days the oil industry cared more about increasing production than profitability. Every time the price of crude rallied, companies would ramp up production, causing the market to flood with additional supply, pushing prices down, and profits would crater. In recent years, many public companies have adopted a new, more disciplined attitude focused on maximizing cash flow generation in order to return that cash to shareholders. That's why a stock like Devon has been such a strong performer. We believe Coterra is clearly taking its cue from Devon. So why add Coterra when we could make our existing position in Devon Energy bigger? Previously, we wanted to our commodities exposure to lean heavily towards more "oily" companies and that's where Devon Energy came in with its commodity exposure about half oil. But given the current state of the global commodity complex and the growing call for Europe to displace Russian gas imports, we want to have a natural gas play in the portfolio too. Over the long term, we think it makes sense to remain bullish on U.S. natural gas as we keep building more natural gas export terminals — you need massive infrastructure to liquefy this stuff so it can transported via ship. That's where Coterra comes into play. Unlike Devon Energy, Coterra has substantial exposure to natural gas. A little more than half of Coterra's revenue this year is expected to come from natural gas and 12% is from NGL, with the last remaining 35% expected to come from oil. While the company has a large presence in the oil-rich Permian Basin, they also have a lot of acreage in Oklahoma's Anadarko Basin and the Marcellus Shale in the northeast. How about the capital returns? Remember, our mantra for this year is that we want to invest in profitable companies that return tons of cash to shareholders and trade at reasonable valuations. Like other U.S. exploration and production companies, Coterra has adopted a fixed-plus-variable dividend policy. The company is committed to returning at least 50% of its free cash flow back to shareholders via its dividend. Given the company's estimated free cash flow this year and projected payout ratios, Coterra offers a roughly 6.5% yield, which is plenty attractive in an environment where the 10-year Treasury yields about 2.82%. And as of its last earnings release, Coterra updated its capital allocation framework to include share repurchases. Last quarter, the company initiated a $1.25 billion share buyback program, which at the time represented 7% of the total shares outstanding. Even after the stock's big run this year, we think Coterra's valuation screens attractively. On an enterprise value to EBITDA ratio, Devon and Pioneer (PXD) have enterprise multiples of 5.3 and 5.5, respectively, while Coterra's substantially cheaper, at 4.9. But we also recognize the magnitude of the move the stock has had, explaining why we are starting off our position on the smaller side today. If we see volatility in the coming weeks, we'll view the weakness as an opportunity to buy more shares and add income (via the dividend) to the portfolio. We are initiating Coterra with a price target of $35, which represents slightly more than 5.5 times 2022 EV/EBITDA. We believe this multiple is justifiable as natural gas prices stay higher for longer and the significant capital returns. (Jim Cramer's Charitable Trust is long DVN. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

In this photo illustration, a Coterra Energy Inc. logo is seen on a smartphone screen.

Pavlo Gonchar | SOPA Images | LightRocket | Getty Images

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