SM Energy Update - July 16

[dan_s]

I get daily reports from Stifel. Here is what they had to say after visiting with SM Energy early this week. - Dan

SM Energy (SM, $40.38, Buy)
Guidance/Financial
Management continues to believe that SM can double its drilling inventory this year without acquisitions while maintaining a strong financial position (Debt/TTM EBITDA of 1.7x at 3/31/15 and first debt maturity in 2021). While it does not expect to de-lever the balance sheet by slowing down its spending levels from last year, it remains focused on generating top-quartile returns on a debt-adjusted per share basis and targets a return on capital employed of 15%. Returns have benefited from an early-mover strategy, which led to an Eagle Ford average acreage cost of only $500/acre.

SM expects to start completing a backlog of uncompleted wells in 1H16, which should
lead to 2H16 production growth while 2016 volumes should be roughly flat y/y. The
company plans to reduce its Bakken drilling activity this year as rig contracts of
$24k/day expire (current rig rates are approximately $18k/day). G&A should decline
slightly following a reduction in administrative staff associated with a 2Q15
Mid-Continent divestiture.

Eagle Ford
Management appears upbeat on five Eagle Ford pilot spacing tests. The formation is
250 feet thick on its eastern acreage in the play including 150 feet in the Upper
section. This compares to the prolific Karnes Trough area to the east where the Upper
Eagle Ford is only 50 feet thick. Flowback recently commenced on a 15-well pilot
testing 450-ft spacing on SM’s eastern block. Thus far, the area has been developed
on 900-ft spacing. The company has also finished drilling a 12-well pilot in a half
section on its northern acreage block. If successful, this test could triple the drilling
density (and inventory) to 24 wells/section from 8/section. Management intends to
analyze pressures and rates from these tests before determining optimum spacing in
each area later this year. These decisions will dictate future infrastructure design.
While pressure pumping costs have declined by more than 70% from 4Q14 levels
($50k/stage from $150k/stage), the company has found vendors are unwilling to enter
long-term contracts on some items such as sand. As such, management anticipates
costs will rebound quickly when oil prices recover. SM is currently completing its Eagle
Ford wells with 2,000 pounds of sand per lateral foot.
Management notes that improved recoveries should have a large impact on the play.
For example, the EIA assumed a 20% Eagle Ford recovery factor in 2013. A 25%
recovery would equate to an additional 7 BBoe from the play.

Bakken
Recent well costs in Divide County, North Dakota range from $4.5 to $5.0mn/well.
These wells are now completed with cemented liners and plug and perf technology
compared to sliding sleeves previously. Management remains optimistic that Bakken
results could double its drilling inventory in an area that has thus far been developed in
the Three Forks formation.

Permian
Despite its small position (17k net acres), SM’s central Upton County, Texas
properties in the Midland Basin could hold 100s of drilling locations (including 90 in the
Wolfcamp B). Several Wolfcamp and Spraberry zones are prospective within a 300-ft
thick section in the region. SM would be drilling this property now were it not for rig
commitments in Bakken. Management indicated that it has no intention of parting with
this property given the recent decline in oil prices.

[setliff]

dan, so what's there that would move the stock? no conclusions?

[dan_s]

Improved results in the Eagle Ford and increasing EURs per acre SHOULD move the stock higher, but nothing is going to help until oil prices stabilize.

[jb2257]

I'm not sure what will stop the slide except maybe some M & A. We were all laughing about Einhorn's calling PXD the "Mother Fracker", but look at the stock price from that day. The shorts are winning and they're not covering yet. If you saw that Seeking Alpha conference on Wed. all the hedge funds were short.

[dan_s]

Actually, the fact that "all of the hedge funds are short" is bullish. Eventually, they have to cover.