Sweet 16 Update - April 25

[dan_s]

Despite rising oil prices, the Sweet 16 pulled back about 1.5% this week. The group is now up 20.6% year-to-date compared to the S&P 500 Index that is up just 2.9% YTD. In my opinion, big money is waiting on the sidelines to see first quarter results.

I have increased my valuations for Diamondback Energy (FANG) to $88.50/share and SM Energy (SM) to $105.40/share.

SM Energy recently reported 1st quarter production that was more than 10,000 boepd above my forecast. I have increased my full-year production to the high end of their guidance. SM is still planning to reduce their drilling program from 17 operated rigs in January to 9 by May and 7 by year-end. They have a strong balance sheet and the flexibility to bring back some rigs if oil prices continue to increase. The company has approximately 49% of this year's crude oil production hedged at over $90/bbl. Based on my forecast model, the majority of this year's $1.2 Billion capital program will be funded by cash flow from operations. First quarter production was 186,400 boepd.

RRC, SM and WLL will be reporting 1st quarter results this week. I will post updated forecast models and my comments shortly after they release results.

Two companies (CRZO and CXO) are now trading above my valuations. XEC, CLR and MTDR are getting close to my valuations. I just need more information, which will come in their 1st quarter results, to justify increasing my valuations.

Oasis Petroleum (OAS) is the only Sweet 16 company down YTD (-1.7%), however I am expecting them to report positive EPS all year and cash flow per share from operations of $3.85/share. Oasis is a pure play on the Bakken / Three Forks play in North Dakota. There is a bit of a "dark cloud" hanging over the Bakken companies because the oil price differential up there is so large (more than $10/bbl). Oasis also has a well servicing subsidiary that will take a hair cut because of the significant slowdown in activity in the Williston Basin. However, the well servicing business is not a significant contributor to their net income. Oasis has ~75% of the crude oil hedged at $91.60/bbl for the first half of 2015. Unless oil prices retreat, I see very little risk of Oasis having any problems with their lenders. They have ~35% of their oil production in the second half of this year hedged at $90.15/bbl.

As the E&P companies report 1st quarter results it is VERY IMPORTANT to focus on cash flow per share and not earnings per share. GAAP accounting rules will result is some wild swings in reported earnings because of ceiling tests, impairment charges and mark-to-mark adjustments on hedges. Investors in this sector need to ignore the "noise" and focus on cash flows and operational updates. Remember, even at $50 oil the cash flows from producing wells are still very good since cash lifting costs + production taxes are only $10-$15 per boe.

There is a lot of "noise" about the increase in wells waiting on completion. Since it takes a lot longer to complete a well and tie it into a sales line than it does to drill it, I estimate there were a lot more wells waiting on completion last summer when over 1,600 rigs were drilling for oil. Today there are only 700 rigs drilling for oil. Analysts that are saying 4,000 to 5,000 wells waiting on completion is a big overhang for oil IMHO are exaggerating the issue a bit. Even if oil spiked to $100/bbl tomorrow, it would take months to get those wells completed and connected to sales. Remember, there are not a lot of completion crews sitting in their trucks waiting to run out and complete wells today. The logistics to mobilize rigs and fracing equipment takes a lot of time.

As I have posted here many times, U.S. oil production is now on decline and the rate of decline will accelerate this summer. Demand for refined products is forecast to increase by 1.5 million barrels per day in the 3rd quarter (See: https://www.iea.org/oilmarketreport/omrpublic/ ) Hang tough, it is going to get very interesting.

[dan_s]

Heads up: I am now doing some special reports for OilPrice.com. I am going to highlight SM in the one that should be published this week.

[dan_s]

RRC and PXD are discussed as Takeover Targets in this interview. I agree those two are candidates and all of our Sweet 16 are prime takeover targets. BTW during the last oil price cycle (2008/2009) six on our Sweet 16 were acquired at large premiums. - Dan

http://www.cnbc.com/id/102618547?__sour ... =102618547