Sweet 16 Update - Jan 5

[dan_s]

My "Christmas Wish" has been fulfilled. Hedge fund managers have (finally) rotated money into the grossly oversold energy sector, especially the upstream companies. With crude oil up four trading days in a row to begin the year, our Sweet 16 companies are all up 5% to 14% at the end of the first week of trading. They still have a long way to go to come close to my valuations. CPE, CLR, GPOR, RRC and SWN are the early leaders; all up more than 10%.

The only thing good about WTI dipping to the mid-$40s is that it will make $50/bbl look good again.
> FEAR, not fundamentals, is what caused the selloff to ridiculously low share prices for this bunch.
> WTI establishing a base in the low $50s will reduce a lot of FEAR.

Every Wall Street firm knows that the price of oil got too low and that sub-$50 oil is unsustainable. They also know that all of the OPEC+ countries cannot balance their budgets at today's prices. Even Saudi Arabia needs Brent oil over $70/bbl to stop the "sucking sound" that is draining their bank accounts. Russia will become the next Venezuela at sub-$50 oil. The lowest oil price forecast for 2019 that I've seen is from Citi, who predicts that Brent will average $60/bbl this year. I've seen several forecast that expect Brent to reach $90/bbl in Q4, primarily because of the impact of IMO 2020 on supply.

Carrizo Oil & Gas (CRZO) and Southwestern Energy (SWN) became official members of the Sweet 16 on January 1st. They replaced ESTE and NFX. NFX will soon cease to exist via merger with EnCana (ECA) and ESTE just moves back to our Small-Cap Growth Portfolio. I am still very high on ESTE, so don't view this as "demotion"; it is just a better fit since they have backed out of the acquisition of Sabalo.

I urge all of you to take a look at Tab 1 on the Sweet 16 spreadsheet and note that Q4 2018 results (Column M) for all of the Sweet 16 are going to be quite good. WTI actually averaged close to $60/bbl in Q4 because it began the quarter so high ($76 in early October) and natural gas prices spiked in November. I am expecting the Sweet 16 to report combined "Adjusted EPS" of more than $12.00 in Q4, which compares to their "Reported EPS" of $9.40 in Q3.

NOTE that Q4 Reported Earnings will include very large mark-to-market adjustments on hedges. Adjusted Earnings are what you need to compare to my forecasts and First Call's forecasts. First Call is a service provided by Reuters.

All of the Sweet 16 individual company forecast models have been update to break out 2019 by quarter and adding my initial forecasts for 2020.
> The commodity prices that I'm using for 2019 are based on WTI being $45 in Q1, $50 in Q2, $55 in Q3 and $60 in Q4. I actually think WTI will rebound to $60 within six months if OPEC+ cuts production to comply with their agreement that was announced in early December. Saudi Arabia has already made significant cuts and their close friends in the Persian Gulf area will also do at they are told.
> For natural gas, I am using $3.00 in Q1 & Q4 and $2.50 for Q2 & Q3.

Mild weather over the eastern half of the U.S. the last few weeks has definitely reduced the likelihood of natural gas spiking to $5.00, but winter isn't over yet. Accuweather is now reporting that conditions in the stratosphere over the North Pole are increasing the chance of a "Polar Vortex" event occurring in the second half of January. Regardless, we are on course for a very low end of winter storage level that should support natural gas prices all year.

Forecast are only as good as the accuracy of the base assumptions used to build the models. So far, only a few of the Sweet 16 have given any production and capex guidance for 2019. I believe the assumptions for production that I'm using for the forecasts are conservative, but time will tell.

The Sweet 16 are all solid companies with more than enough liquidity to survive a few quarters of $45 to $50 oil. My hope is that we don't have to test that assumption.

PS: I spent the first five days of January updating all of the forecast models for our Small-Cap Growth Portfolio companies. You can find them on the EPG website. I will be updating all of the forecasts for the High Yield companies next week.