Energy Prospectus

The Sweet 16 Growth Portfolio spreadsheet has been updated and posted to the website:
> Tab 1 of the spreadsheet is a summary of the EPS and CFPS forecasts,
> Tab 2 shows my Fair Value Estimate compared to First Call's Price Target for each company as of 12-19-2014

EPG members can find the individual company profiles and forecast models under the Sweet 16 Tab by clicking on the company logos.

The Sweet 16 made a nice comeback this week, but it is still down 22.9% YTD. This will probably end up being the 2nd time since 2001 that the Sweet 16 netted a loss for the year (the only other year being 2008). What's weird is that for most of the companies in the portfolio, this will be the best year in their company's history.

2008 was by far the worst year for the Sweet 16. It was followed by great years in both 2009 and 2010. In 2010 the Sweet 16 finished up more than 54% and we had four companies more than double in share price that year.

Today, each company in the Sweet 16 is trading at a significant discount to both my Fair Value Estimate and the current First Call Price Targets (see Tab 2 of the spreadsheet). Unless you believe crude oil prices are going to stay down FOREVER, these stocks are grossly oversold. At least for this week, it appears that Brent is settling in around $60/bbl. Remember, all in cash production expenses (production taxes, LOE, gathering, processing and transportation) are under $12/boe for most of the Sweet 16, therefore they are still making historically good netbacks.

What we saw confirmed this week is that there is a lot of cash on the sidelines waiting to pile into this sector when investors feel that crude oil prices have set a bottom. Despite all the "gloom and doom" all of the Sweet 16, except for Sanchez Energy (SN), are expected to report solid 4th quarter earnings.

"---except for Sanchez Energy (SN), are expected to report solid 4th quarter earnings."


so, what's wrong here? why won't sn be good?

SN is likely to report "Adjusted Earnings" of less than 1 cent per share in Q4. "Reported Earnings" will include a big gain on their hedges and may include a ceiling test writedown. Cash flow from operations should be approximately $1.50 per share for the quarter (compared to $1.66/share in Q3).

Several analysts have recently submitted forecasts to First Call with a small loss for the quarter. I am just trying to warn you since this market may have a knee jerk reaction to a reported loss.

SN is still outspending their operating cash flows by a wide margin, which is not a big hit with the Wall Street gang these days. Plus, the company has a lot of debt.

My forecast for 2015 assumes production of 50,000 boe per day, compared to production of approximately 45,000 boepd today. If Sanchez is forced to significantly reduce capital spending in 2015 (likely if oil prices stay low for long), then I believe First Call's EPS forecast for 2015 is way too high.

You can find my detailed forecast model for SN under the Sweet 16 Tab.

Definition
So what exactly is a ceiling test impairment charge? The Securities and Exchange Commission (SEC) requires exploration and production companies that use the "full cost" method of accounting calculate a "cost center ceiling" and compare that ceiling to the net capitalized costs of oil and gas properties. If the capitalized costs (on the company's books) exceed the ceiling, a non-cash charge is taken. The ceiling is comprised of several components, but it can generally be defined as the present value of future net cash flows from proven reserves, using a 10% discount rate, with end of year commodity prices held flat for the life of the reserves.

Companies that use the "successful efforts" method of accounting (SE) also must account for impairments, but by way of a different formula. SE companies are required under FAS 21 to write down their proven properties to the net present value of each properties future cash flows. SE is more conservative than the full cost method of accounting.

It is important to remember that these writedowns are for book purposes only. It does not mean the properties have been abandoned or that the underlying oil and gas reserves have gone away.

Just to clarify. SN will survive and my Fair Value Estimate is still $25.80, until I have more information. First Call's Price Target is now $22.31.

Bonanza Creek (BCEI) is getting a nice boost today since it was added to the S&P SmallCap 600. IMO it was one of the most oversold stocks in the Sweet 16.

Bonanza Creek has a 52-week trading range of $16.36 - $62.94, with the low set a week ago. The high was in July. Anyone that got it at the low got a heck of a deal. First Call's Target Price of $41.73 looks reasonable to me. In fact, I have to take the company's realized oil price (including hedges and regional differentials) down to $50/bbl to get close to that valuation.

You can find my updated Net Income & Cash Flow Forecast model for BCEI under the Sweet 16 Tab.

What happens when any company is moved into an index is that a whole bunch of analysts are forced to take a hard look at it. When the stock price goes up over the next few days, you can bet they really liked what they saw, especially in a beaten down sector like upstream oil & gas.

Here is why I think BCEI is still a good buy today.
Year / Daily Production / Cash flow Per Share
2012A: 9,304 boepd / $3.90
2013A: 16,155 boepd / $7.12
2014E: 23,764 boepd / $8.45 < 12/31/2014 exit rate should be ~29,000 boepd (65% crude oil, 30% natural gas, 5% NGLs) Note that their high btu gas sells at a premium to NYMEX
2015E: 32,000 boepd / $7.93

In the 3rd quarter, Bonanza Creek's all in cash production expenses (production taxes, LOE, gathering, processing, transportation and marketing) were $14.30/boe. Fuel costs are a big part of production expenses and production taxes go down in lock step with commodity prices, so production expenses in 2015 will probably drop below $13/boe. So, if the company's average realized price drops to $50/boe, they will still be making $37/boe in cash flow at the wellhead. Historically, that is still a darn good netback.

I have been working in the upstream oil & gas business for over 35 years. During that period I've seen several oil price cycles, most of which were much worse than this one. Well managed companies adjust their spending quickly and they survive. All of the Sweet 16 will not only survive, but they will continue to grow production and proven reserves.