Drilling Down at XTO

One of the hottest energy companies of recent years, XTO Energy(XTO Quote), is expected to report another blowout quarter Tuesday, driven by high commodity prices and expanded production.

The Fort Worth, Texas-based natural gas producer, whose market cap has swollen to $12 billion from $2 billion in five years, has already told Wall Street that second-quarter production will rise by 25% from a year ago, reflecting the addition of 775 billion cubic feet to its reserve base through $1.3 billion worth of acquisitions. In 2004, it acquired 1.3 trillion cubic feet of reserves for nearly $2 billion.

The stock, which is up 35% in 2005, closed Friday at $35.75, about 14.5 times its expected 2005 earnings of $2.46 a share.

Though analysts are confident that XTO will make its production target, opinions differ slightly about the bottom line.

"Of the [exploration and production companies] under my coverage, XTO is the one I have the most confidence in," says Kim Pacanovsky, oil analyst at KeyBanc Captal Markets, citing management's reputation for conservative guidance. (Pacanovsky's firm has had an investment banking relationship with XTO in the past.)

XTO's method has been to acquire vast amounts of natural gas-rich properties where long-lived reserves with a predictable yield are known to exist. The company applies advanced technology to hard-to-extract rock such as shale and tends to drill as many wells as possible at each property, even if each yields only a couple million cubic feet of gas.

The strategy has resulted in impressive production growth at a time when natural gas prices have been surging. They're up 22% in 2005 alone to a recent $7.60 per thousand cubic feet. The average gas price between 2000 and 2002 was as little as $3.30 per thousand cubic feet.

Still, Pacanovsky expects the company to earn 56 cents a share in the second quarter, about 4 cents below the Thomson First Call consensus. The company earned 41 cents a share a year ago.