Energy Prospectus

The Sweet 16 gained 2.09% during the week that ended August 11, rarely does it go up when I am on vacation. The portfolio is now up 12.34% YTD with all of the gains over the last few weeks. I still expect the Sweet 16 to finish 2023 with a 50% gain. Hang Tough because The Big Paradigm Shift is just starting to get fun.

The S&P 500 Index lost 0.36% during the week and it is now up 16.27% YTD. Fear of the Fed will be with us for a few more quarters. At least Fear of Recession seems to have faded away.

The Sweet 16 closed August 11th 46% below my current valuation.

Three of the gassers (AR, EQT and RRC) have moved over my valuations. This does not mean they won't move higher; this is the time of the year when a lot of fund managers (that don't know much about the actual energy sector) rotate into the gassers. I do expect HH natural gas prices to drift over $3.00 before the end of October, but I remain concerned about the large surplus of natural gas in U.S. storage (305 Bcf over the 5-year average on August 4.) I am therefore "short-term bearish" and "long term bullish" on all of our gassers. If we have a mild start to winter, we will see U.S. natural gas prices pull back quickly. If we have a normal winter, we should be looking at HH gas prices over $4.00 a year from now.

Comstock Resources (CRK) still trades at a 21% discount to my current valuation of $15/share. Just keep in mind that CRK is a "pure gasser". I like the Company's "running room" in the Western Haynesville. Comstock continues to report incredibly strong well results and they have over 1,500 low-risk HZ development drilling locations.

All 16 companies have now released Q2 results. Q2 should be the low point for this year's financial results as oil & gas prices should be higher in Q3 and Q4. Always remember that "Reported Net Income" should be ignored since it includes some GAAP/SEC adjustment that can be misleading. Adjusted Net Income is what you should compare to my forecasts and those of First Call and TipRanks. Most notable is the $1.74/share Q2 loss reported by Callon Petroleum (CPE) which included a $406.9 million ($6.57/share) non-cash charge for impairment. Callon is on-track to $225 million of free cash flow from operations this year with strong Q3 results locked in.

CPE at $36.82 trades at the deepest discount to my valuation of $84.50/share. First Call's price target of $46.48/share has started to drift higher. Callon has made a lot of progress on cleaning up their balance sheet this year and 2024 is setting up to be a big year for this mid-cap. There is nothing that I can see that justifies CPE trading at just 2X operating cash flow per share.

Vital Energy (VTLE) is another good example of how misleading Reported Net Income can be. Vital reported eye-pooping EPS of $15.86 for Q2 that included a non-cash $222.3 million deferred tax benefit ($11.96/share). The adjustments booked by Callon and Vital in Q2 cover multiple years, so recording the full amount in one quarter is extremely misleading.

Vital's Q2 operating cash flow per share of $11.30 beat my forecast, plus they raised their production guidance and lowered their capital expenditure budget; both of which increase operating cash flow. My current valuation increases by $12 to $134/share. My valuation is only 3X annualized operating CFPS, which is very low for a company with plenty of "running room". The Wall Street Gang is still skeptical with TipRanks' price target sitting at $67.50. Vital is once again the front runner for most profitable Sweet 16 company on a per-share basis. The Company will report a significant increase in production from Q2 to Q3 thanks to the Forge Energy Acquisition that closed on June 30th. We will be publishing an updated profile on Vital this week. Vital's only negative for me is that the total debt level is a bit too high, but they have no near-term debt problems and plenty of liquidity. Operating cash flow covers 100% of their D&C expenditures.

We will be publishing an updated profile on SilverBow Resources (SBOW) this week. It has moved into the Sweet 16 lead, up 39.18% YTD. It still has lots of running room to reach my valuation of $68.00.

Earthstone Energy (ESTE) remains my Top Pick since it is going to report a big increase in production from Q3 to Q4 that the Wall Street Gang still has not fully realized. First Calls price target of $24.75 is starting to drift higher. It compares to my valuation of $32.00.

I will be recording a podcast this afternoon and I will have more comments on the Sweet 16.

On Monday and Tuesday I will be updating the forecast/valuation models for several of our Small-Cap Growth and High-Yield Income portfolio companies.

Though Callon’s $406 million write off was not entirely a current period cash expenditure it was in fact cash spent in some not to distant past period and it’s write off shouldn’t be totally ignored. I view it as a significant economic loss and a hit to equity value.

With regards to Vital’s operating cash flow you seem to indicate its lowered capital expenditure levels are influencing factors. Please explain its impact.

Callon's book value of the Eagle Ford assets came as a result of their merger with Carrizo in late 2019. Callon needed the cash from the Eagle Ford sale to close the Permian Basin acquisition. IMO the combined deals makes Callon's balance sheet stronger, with excess cash used to pay down debt. IMO Callon is a more attractive company as a pure play on the Permian Basin.

Vital lowered capex and increased production guidance. Higher operating cash flow with lower capital expenditures = more free cash flow. My valuations are based on a reasonable multiple of annualized operating cash flow per share. Profitable companies that are funding production growth with operating cash flow AND generating free cash flow deserves to trade at more than 3X annualized CFPS.

I own CRK and CHK both gassers. Sounds like it would be good to get out of both of them and move money into some of the oil stocks.

No rush to sell the gassers, BUT as I pointed out in my podcast there is significant near-term risk for natural gas prices. IMO the short term outlook for crude oil prices is much better.