Sweet 16 Update - March 25

[dan_s]

I am going to push back the next edition of The View From Houston newsletter because I am going to make several changes to the Sweet 16 Growth Portfolio effective April 1st. Callon Petroleum (CPE) is definitely being added.

Thanks in part to the confusion in Washington, the S&P 500 Index declined 1.53% last week. It is still up 4.70% YTD. The Sweet 16 declined 2.60% last week and is now down 13.51% YTD.

The fundamentals don't support the lack of confidence investors seem to be having in the upstream oil & gas companies.
> Commodity prices are much higher in the first quarter than they were a year ago.
> First quarter results are going to look great compared to Q1 2016 (when oil dipped below $30 and natural gas dipped below $2.00).
> The Sweet 16 are all rock solid companies and most of them have double digit production growth locked in.
> Six of the Sweet 16 (FANG, GPOR, PE, PDCE, RRC and RSPP) expect to increase their production this year by more than 30%. < See individual forecast models for production guidance.
> The U.S. natural gas and NGL markets have firmed up quite well and 2H 2017 prices should move higher, no matter what oil prices do. There is a lot of industrial demand coming online this summer for both gas and NGLs. Exports are also increasing.

After reading the IEA's latest Oil Market Report, I am more confident in my opinion that demand for oil will exceed supply in Q2 and may exceed it by a lot in Q3.

Despite weakness in the stock market, First Call's target prices for the Sweet 16 have moved higher since Q1 results came out. About half of them moved higher last week.

My valuations for each of the Sweet 16 can be found on the EPG website (see "Sweet 16 Forecasts and Portfolio" on the website home page). On the spreadsheet, right next to my valuations, you can see First Call's price targets as of March 24.

The Sweet 16 spreadsheet has two tabs. You can view it on the website or download it to Excel, where it may be easier to view.

Tab One shows:
> the market cap of each company,
> balance sheet summary so you can see how much debt they have,
> GAAP earnings per share for 2016 (all 16 reported losses last year), my EPG forecast by quarter for 2017 and for the year 2018
> MOST IMPORTANT: Operating cash flow per share for 2017. "Cash pays the bills, not earnings" and I value each company based on a multiple of cash flow per share.

Tab Two shows:
> When I added each company to the Sweet 16
> How they have done YTD and since I added them to the Sweet 16
> My Fair Value Estimate compared to First Call's Price targets for each company
> Proven reserves as of 12/31/2016 divided between gas and liquids.

The value of any upstream oil & gas company is not what they have done in the past (although it does help me forecast the future), but what they are going to do. Most of the Sweet 16 are "PRIME TAKEOVER TARGETS" and that is how I value them. For example, a company like Parsley Energy (EP) deserves a high valuation (FC's price target is $45.32) because it has 70% YOY production growth locked in and lots of high potential drilling inventory in the red hot Permian Basin. It also has strong cash flows and access to all the capital it needs to fund an aggressive drilling program. Parsley's proven reserves are just a small percentage of the potential (3P) reserves it holds in inventory.

GAAP accounting rules are extremely conservative for upstream oil & gas companies. I won't get into the "weeds" here, but it is insane for any upstream company with strong operating cash flows to trade below GAAP book value. AR and SM closed below book value on Friday. GPOR and RRC are trading very close to book value. All four have a lot of natural gas and NGL production, which is the only justification that I can see for their low market-caps. RRC's production guidance is for 33% to 35% production growth this year and they hold some of the most valuable leasehold in North America. Based on my forecast, RRC will generate over $1Billion cash flow from operations this year. That is more than double the cash flow they had in 2016. RRC holds more than 100 Trillion Cubic Feet of recoverable gas in the Marcellus/Utica play and they have one of the best marketing teams in the world.

As I point out week after week in my podcasts, sometime in April the impact of the OPEC production cuts and increasing demand for refined products made from crude oil will show up in the EIA weekly oil storage reports. When crude oil inventories roll over, I predict the Wall Street Gang will rotate a lot of money into the upstream oil & gas companies.

Keep an eye on the refinery utilization rate: https://www.eia.gov/dnav/pet/pet_pnp_wiup_dcu_nus_w.htm
when it goes over 90% the crude oil in storage will decline.
FYI: The Houston Chronicle reported on Saturday that Halliburton will be hiring 2,000 new employees in Q2 so that they can hold onto their market share.

[dan_s]

Carrizo Oil & Gas (CRZO) will be promoted to the Sweet 16 on April 1. It has 15% to 20% production growth locked in through 2020.

CRZO closed at $26.90 on 3/24 and First Call's price target is $46.00. Trading at less that 5X operating cash flow per share, this is one you should take a hard look at.