Sweet 16 Update - Nov 13

[dan_s]

During the week ending November 12 the Sweet 16 lost 7.26% and it is now up 158.75% YTD. This compares to the S&P 500 Index that lost 0.4% and is now up 24.67% YTD.

What caused the dip? WTI crude futures edged lower to below $81 per barrel on Friday and the front month contract has now declined for three weeks in a row. Natural gas prices also pulled back. WTI is being pressured by an inflation-driven US dollar rally and investors are watching to see what Team Biden will do in an effort to curb rising gasoline prices (grasping at straws to improve Joe's terrible approval rating). There is the FEAR that Covid-19 cases will increase during the winter and cause travel restrictions. IMO the Covid-19 FEAR is the "Boy that cried wolf", so it needs to fade away.

OPEC said in its monthly report that it expects oil demand to average 99.49 million barrels per day in the fourth quarter of 2021, compared with about 99.82 million bpd from last month’s forecast, as higher energy prices could hurt demand. The same report also cited higher energy costs as a factor in the slowdown of the global recovery and lower demand from China and India, with spillover effects through wider sectors of the economy as shown in latest inflation figures.

Increasing demand for space heating fuels: Some real winter weather is moving across the Great Lakes region this weekend and an extended cold spell is expected in Europe. This will be the 2nd year in a row of La Nina's impact on the world's weather system. Year Two La Nina's have caused some of the coldest winters on record for North America because La Nina caused big dips in the jet stream. If Europe has a cold start to winter they will be begging at the alter of Putin for more gas supply.

Continental Resources (CLR) and EQT Corp (EQT) were the only two Sweet 16 stocks to move higher during the week. CLR rebounding from the previous week's pullback due to the $3.25 billion acquisition from Pioneer Natural Resources (PXD) they announced on November 3rd. I view the deal as a "win-win". It will be accretive for CLR as long as oil stays over $60/bbl and it gives the company a 4th core area with long-term growth potential. PXD will use the proceeds to pay off a large chunk of debt and they have more than enough Tier One leasehold in the Midland Basin to quickly replace the production they are selling (~55,000 Boepd with ~70% oil). PXD will some being BIG DIVIDENDS, so I may move it to our High Yield Income Portfolio along with Devon Energy (DVN).

EQT is the only Sweet 16 stock that is still trading below book value. IMO that is insane since EQT is the largest natural gas producer in North America. Even with some "Bad Hedges" extending into 2022, my forecast model shows that the Company's operating cash flow will increase from $2.1 billion in 2021 ($6.44/share) to $4.4 billion in 2022 ($11.56/share).

Talos Energy (TALO) lost 19.3% during the week ending Nov 12th after announcing that affiliates of Apollo Global Management and Riverstone Holdings are selling 6 million shares with an underwriter option to sell another 900,000 shares. This is a big chunk of Talos' 81.9 million shares of common stock outstanding, but it does not directly impact the company. It does not change my valuation of $29/share. On November 4th Stifel analyst Michael Scialla raised the price target on Talos Energy (NYSE: TALO) to $26.00 (from $25.00) while maintaining a Buy rating.

After each company announces quarterly results and fresh guidance I update my forecast/valuation models within a few days. All of my forecast models have now been updated and you can view them directly from the EPG website. They are macro-driven Excel spreadsheets that you can download to Excel on your computer and adjust production volumes and commodity prices to see for yourself how they impact revenues, earnings and operating cash flow. IMO these spreadsheets are the most valuable tool we provide you. Learning how to use them is up to you.

When the dust settles a bit we update each company's profile and I go over the forecast models again line-by-line, often tweaking a few of the numbers. The EPG Team consists of four very sharp young MBAs (3 from SMU and one from Texas Tech) that draft each profile update. They are a valuable asset and a great help to me. They keep me in line.

I review each profile carefully before we post it to the EPG website. The team does a great job and I rarely make any significant changes to what they do. All of the stock valuations are my own opinion. All of the valuations are based on company provided guidance and on the assumptions that WTI oil will average $75/bbl in Q4 2021 and $80/bbl in 2022 and that Henry Hub natural gas prices will average $5.00/MMBtu in Q4 2021 ad $4.25/MMBtu in 2022. I make adjustment in each model for regional oil & gas price differentials and each company's hedges. For NGL prices it is a bit more of a SWAG, but I do my best to be conservative on commodity pricing.

Since EPG was formed in 2006 this is the BEST YEAR EVER for the Sweet 16, so is it time to harvest profits? That is up to each of your and I will admit that, like most investors, I am terrible at market timing. That said, IMO the Sweet 16 is still under-valued by the market.
> Based on my forecast models, the portfolio is trading at a forward looking PE ratio of 5.97 X 2022 EPS estimates. Most of the S&P 500 Index stocks trade at PE ratios over 20.
> More important, the Sweet 16 is trading at 2.93 X 2022 estimated operating cash flow per share. A group of this quality should be trading for at least 6X CFPS.
> IMO the steep backwardation of the NYMEX strip for oil is out of touch with reality. The world is currently "short oil" and IMO will get much tighter next summer when OPEC+ runs out of spare capacity. I know it is counter-intuitive, but backwardation is bullish for oil. It tells us that refiners are willing to pay up for more oil supply. U.S. oil inventories are 7% below the 5-year average for this time of year and they MUST build so we have enough raw material for the home heating oil and transportation fuels this country needs.
> I also believe there has been a "structural change" to the U.S. natural gas and NGL markets. Unless we have an extremely mild winter, I think HH gas will stay over $4/MMBtu and it is a good bet that gas prices will go a lot higher in December.

We have published updated profiles on AR, CPE, CLR, EOG and RRC. The others will all be updated by the end of November, my goal is to get them out before Thanksgiving, but the goal posts keep moving.

I have updated all of the Small-Cap Growth Portfolio forecast models except for NOG and ROCC, which I plan to finish today. Hemisphere Energy (HMENF) will be announcing Q3 results next week and Don Simmons, the CEO will be coming to Houston to host a luncheon for us on November 30. HMENF is one of my Top Picks.

[SergioSays]

Dan, great write-up. Kudos to you and your team. Enjoy your well-earned vacation.