Sweet 16 Update - Feb 5

[dan_s]

The Sweet 16 gained 4.92% during the week ending February 4 and it is now up 18.46% year-to-date.
The S&P 500 Index gained 1.45% during the week and is now down 5.57% YTD.

I expect the overall market to face the headwind of Fed tightening policy all year, but I don't expect to see a significant market correction. The Fed is tightening because the economy is heating up in "Post-Pandemic World". An expanding economy should be good for stocks. I would stay away from companies exposed to higher energy prices and to supply chain problems, which will take a lot of time and diesel to fix.

In addition to higher oil and gas prices that draw more attention to the Sweet 16, they are all in much better shape than they were a year ago. All of the Sweet 16 generated a lot of free cash flow last year and lots of it was used to pay off debt. Free cash flows are increasing. NONE OF THE SWEET 16 HAVE A NEAR-TERM DEBT PROBLEM.

Paying off lots of debt also lowers interest expense going forward.

Higher commodity prices will increase Proved Reserves (P1), which in turn will lower DD&A expense going forward.

A lot of "Bad Hedges" expired at year-end 2021 and going forward they will have less production hedged and the ability to use collars to protect downside risk and keep exposure to higher oil & gas prices. Keep in mind that hedging programs are used to stabilize revenues. We all wish they did not hedge when commodity prices are going up and we call them idiots for not hedging when commodity prices are going down. Several of the Sweet 16 would have been forced into Chapter 11 in 2020 if not for their hedging programs.

Q4 results should be good and Q1 2022 results should be fantastic.

Leading the pack are:
> EOG Resources (EOG) up 28.0%
> Continental Resources (CLR) up 27.9%
> PDC Energy (PDCE) up 25.9%
> Matador Resources (MTDR) up 24.6%

Only two are down YTD:
> EQT Corp. (EQT) down 1.1%
> Comstock Resources (CRK) down 0.25%
Both are "gassers" that are trading at deep discounts to my valuations. Both should have big increases in free cash flow this year.

Q4 / year-end results always take longer to get out because upstream companies must include updated reserve reports in their 10-Ks. Plus Sarbanes-Oxley compliance work also takes more time at year-end. I expect CLR to be the first company to report Q4 results on February 14, followed by AR & CRK on Feb 16 and MTDR on Feb 17.

My updated Sweet 16 spreadsheet will be posted to the EPG website this afternoon. Keep in mind that my current valuations shown on Tab 2 of the spreadsheet and First Call's price targets are based on oil & gas prices that are much lower than we have today. I will be adjusting the oil, gas and NGL prices when I update the individual company forecast/valuation models. Since I will only be increasing commodity prices for 1H 2022 it won't have a big impact on my valuations. Their detailed guidance for 2022 is likely to have a much larger impact since a higher confidence level in my forecasts for 2022 will allow me to raise the multiple of operating cash flow used to value them.

Several companies will be announcing significant increases in dividends and stock buybacks.

Magnolia Oil & Gas (MGY) has moved closest to my valuation, but it still has a lot of upside for us. My current valuation of $26.00 looks too low each day because MGY is heavily weighted to oil and none of their production is hedged. MGY does pay a dividend and they have a lot of free cash flow to fund an aggressive share buyback.