Sweet 16 Update - March 26

[dan_s]

Since the markets are closed for Good Friday, I am posting my weekly Sweet 16 Update a day early.

After three strong weeks, the Sweet 16 pulled back 3.64% last week. As a group the Sweet 16 is now up 7.34% YTD, compared to the S&P 500 Index that is down 0.67% YTD.

SM Energy was up slightly for the week and the other 15 were down slightly. Oil prices pulling back a bit after Wednesday's bearish crude oil inventory report is the main reason, but some profit taking was expected after a strong run of over 15% in the three prior weeks. Oil prices firmed up after the Baker Hughes (BHI) weekly active rig count report showed another big decline. The record decline in rigs drilling for oil & gas (lowest count in over 70 years) will cause U.S. production declines to accelerate as the year rolls on.

First Call's price targets for most of the Sweet 16 were raised last week. I watch the First Call price targets carefully and I urge you to do the same. I am more concerned with the direction they take than how they match up with my valuations. Pay the most attention to how they move in the weeks after quarterly reports come out. First Call's price targets change when they receive new forecasts from analysts. FC is a service of Reuters.

As I posted earlier, I took a very hard look at PDC Energy (PDCE) this past week since I highlighted the company in a special report that I wrote for OilPrice.com. It has a strong balance sheet, over half of this year's oil production hedged at $80.95/bbl and production growth locked in. That combination is hard to find these days. The share price definitely has upside beyond my valuation of $88/share when oil prices rebound.

The "gassers" (AR, RRC and GPOR) may get a bit of a boost from a late season winter storm that is now expected the first week of April. The cold won't last long enough to make much of a difference in the very high amount of gas that remains in storage. but every little bit helps. I hope you all read the Robert Rapier comments on the natural gas market that we e-mailed to EPG members on 3/24. Robert and I are in agreement that the U.S. gas market will be much tighter within 6-8 months. AR, GPOR and RRC are all super high quality companies. Robert told me today that his favorite gassers are COG and EQT. We will publish profiles on them in April.

Laredo Petroleum (LPI) will be moved back to the Small-Cap Growth Portfolio when I can find a good replacement. In addition to its low market cap, the company has a lot of debt and production will probably slide back a bit (2% to 4%) this year. If WTI does not rise to $60/bbl by year-end, the debt level could become an issue. With 85% of this year's oil production hedged at $70.84/bbl there is no near-term risk.

Range Resources (RRC) was downgraded by Barcleys on Thursday. If it does pull back into the $20s I recommend adding it as a Core Holding. RRC is a super high quality company with an extremely valuable acreage position in the Marcellus/Utica.

XEC, FANG and PXD are approaching my valuations.

SM Energy (SM) is still trading at less than half of my valuation.

In the "Elite Eight", DVN and NFX appear to have the most upside.
> Devon Energy (DVN) has several large asset packages for sale. If they get close to their asking prices (over $2 Billion in total) the stock should take off. Devon is a company "in transition" and this market does not appreciate how good it will look by Q4.
> Newfield Exploration (NFX) is my Top Pick for the STACK play. Earlier this month, Credit Suisse issued a report on NFX with a price target of $42. Stifel sent out an update on 3/21 with a net asset valuation ("NAV") of $44/share. Newfield's STACK wells are now producing at rates above the type curves which were used in their year-end reserve report. What this means is that we can expect a significant upward revision to their proven reserves at year-end. NFX has ten rigs running in STACK. Quote below is from the Stifel report.

Three-Pronged STACK NAV Upside Possible: "We see potential to add
$13/share to our risked STACK NAV, increasing our risked NFX total NAV 30% to
$57/share. Cost Reductions: Well costs in 2016 are expected to average $7.3
million, down 12% y/y, but still 15% higher than projected full development costs
($6 million). Incorporating a $6.5 million well cost, our STACK NAV would increase
12% to $28/share. Locations: Our NAV assumes 8 Meramec wells per 1,280
section, across 75% of the company's 230,000 net acres prospective for the
Meramec. Throughout the play, XEC is testing 10 wells/section (five in upper and
five in lower zones) while DVN is testing 8 wells/section in the Upper Meramec
(excluding the Lower Meramec). If we were to increase our development
assumptions to 10 wells/section, our STACK NAV would increase 18% to
$29/share. Well Performance: Should well optimizations/improved performance
justify a 10% increase to our type curve, our STACK NAV would increase 23% to
$30/share"

Newfield is one of the likely buyers of the Gastar leasehold for sale in Canadian county. They are completing very good wells close to that acreage block.

[mkarpoff]

Great update. Thx.