SM Energy (SM: NYSE)
By Global Hunter ($56.51, Oct. 22, 2012)
We are initiating coverage of SM Energy with a Buy rating and a $70 price target.
We like SM Energy (ticker: SM) for three principal reasons. First, its 283,000 net acres in the U.S.'s two premier oil/liquids-rich shale plays (Eagle Ford and Bakken) provide a tremendous amount of development visibility and reliable growth over the next five years. Second, SM Energy arguably has the most irons in the fire in terms of resource play concepts it is currently testing; many times the biggest incremental driver to a company's net asset value (NAV) isn't in your Excel spreadsheet, and we feel SM Energy has the technical talent and strategy to repeat the success it has achieved over the last five years with its early resource capture business model. Third, valuation—SM Energy is trading for 4.3 times 2013 estimated enterprise value/earnings before interest, taxes, depreciation, amortization and exploration expenses (EV/Ebitdax) versus our universe at 4.6 times, while poised to outpace its peers in terms of both production and NAV growth.
SM Energy is commonly characterized as an Eagle Ford player with a Bakken kicker—collectively, both basins account for about 60% of SM Energy's production and are garnering 70% of 2012's capital expenditures. SM Energy holds core-net acreage positions of 196,000 and 87,000 acres in the Eagle Ford and Bakken, respectively, which represent an undrilled inventory of 1,825 wells and 1,023 millions of barrels of oil equivalent (MMboe) unrisked reserves—close to five times SM Energy's current proved number of 210 MMboe.
During the second quarter, fabrication delays and equipment shortages of critical midstream infrastructure restricted production and caused completions to be pushed back in the Eagle Ford. However, the issues have largely abated as five of six tank batteries that were set to be received in second-half 2012 have indeed been delivered. Operated Eagle Ford production has since ramped (240 million cubic feet equivalent per day (MMcfepd) in August versus 207 MMcfepd during the second quarter).
In our eyes, SM Energy's hard work done in the Permian basin over the last three years is due to pay off in spades. We believe that Permian delineation presents the highest potential NAV accretion for the company over the next 12 months. SM Energy's latest Mississippian results in the Permian's northern Midland Basin (average 30-day initial production (IP) rates at 540 barrels of oil equivalent per day (boepd) and 85% crude) have us encouraged, and with 115,500 net acres assembled and four rigs running (as many as are in the Bakken), we estimate that the play has the potential to deliver $10 of incremental value to shareholders in 2013.
If the Permian doesn't pan out, SM Energy has a number of other resource shots on goal. SM Energy's early resource capture strategy has made SM Energy one of the stealthiest exploration and production (E&P) firms in its peer group. At any point in time, SM Energy will be working on 12 different exploration concepts, as the company devotes more than $100 million a year to exploration. The model worked to perfection in the Eagle Ford ($250 per acre entry price) and management intends to show it is not a one-trick South Texas pony.
SM Energy grew production 55% in 2011 and has guided 2012 growth at 23%-27%. Production growth on a debt-adjusted, per-share basis (our preferred metric), is also above peers: year-over-year growth in the second quarter was 8% versus the 2.4% median seen from the 45 companies in our U.S. E&P universe. We forecast SM Energy's debt-adjusted-production growth to accelerate to 14% in 2013, as SM Energy's cash-flow/capex gap narrows versus 2012.
SM Energy's second-quarter production was 28% oil, 16% natural-gas liquids and 56% gas. Management has guided to a 50/50 liquids/gas mix in 2014, but we think SM Energy may get there as early as second-half 2013 with success in the oily Permian. Eight of SM Energy's 16 rigs are now either in the Bakken or the Permian and the five rigs running in the Eagle Ford are focused on drilling its liquids-rich acreage to the north.