Sweet 16 Update - August 13

[dan_s]

The Sweet 16 had the best week of the year. Solid Q2 results combined with firming oil prices did it.

For the week ending August 12, the Sweet 16 was up 7.41% and is now up 42.03% YTD. The S&P 500 Index was up just 0.06% for the week and is up 6.86% YTD.
Wall Street now recognizes that the strong companies are going to survive and these companies have adjusted to a lower commodity price environment.

One thing I watch carefully is the movement of the First Call price targets in the weeks following quarterly results. FC's price targets are the average valuations of individual analysts' forecasts submitted to Reuters. It takes a few weeks for all of them to be updated. FC price targets have increased for all 16 companies since they released Q2 result. Three of the Sweet 16 saw big jumps in their FC price targets this week:
> Cimarex Energy (XEC) increased $7.54 to $140.19 (compared to my valuation of $134.00)
> EOG Resources (EOG) increased $4.81 to $94.17 (compared to my valuation of $97.00)
> Parsley Energy (PE) increased $3.00 to $36.93 (compared to my valuation of $34.50)

Diamondback Energy (FANG) is the darling of Wall Street. First Call's valuation goes up each week. FC's price target is now $105.93, compared to my valuation of $95.00. FANG is trading at more than 23X my operating CFPS forecast and I cannot justify a higher valuation. That does not mean the share price won't go higher. Their ownership stake in Viper Energy Partners (VNOM) is the only thing that I see which deserves a higher multiple. FANG is a solid company with a lot of running room in the Permian Basin.

Devon Energy (DVN) is a company "in transition". When all of their non-core asset sales close this quarter, the balance sheet will be in good shape and I think Wall Street will be moving more money into the large-cap STACK companies. Devon has one of the best positions in the play. CLR, NFX and XEC also have large positions in STACK and they are all increasing their activity in the play. NFX has the most exposure to STACK. CLR seems to be getting the best well results in the over-pressured area (primarily in Blaine County).

STACK is the only area where well results are better than they are in the Permian Basin.

SM Energy (SM) announced a large acquisition in the Midland Basin (a sub-basin of the Permian Basin). They will acquire 24,783 net acres in Howard County, West Texas, expanding the Company’s Midland Basin footprint to approximately 46,750 net acres. The acquired acreage position is largely contiguous and includes approximately 4,900 Boe per day net production (with two new wells coming on-line August 2016) and 6 MMBoe of proved developed producing reserves. The purchase price is $980 million and the seller is Rock Oil Holdings LLC. This gives SM a second core area and (more important to us) it will draw a lot of Wall Street attention. Wall Street loves the Permian Basin and they should be impressed with SM's share price compared to its operating cash flow per share. SM's share price is 4.1X operating CFPS. FANG's share price is 23.7X operating CFPS. PE's share price is 20.1X operating CFPS. SM is up 66% YTD, but I think it has at least 50% more upside for us.

Our three "gassers" (AR, GPOR and RRC) are all trading at deep discounts to my valuations. Wall Street will focus on the gassers as winter heating season approaches. The natural gas storage level should be close to the 5-year average by the time winter begins.

RSP Permian (RSPP) has been added to the Sweet 16. It replaces Carrizo Oil & Gas (CRZO), which has been added to our Small-Cap Growth Portfolio. There is nothing wrong with CRZO. It was just the smallest company in the Sweet 16. Read the RSPP profile we sent out on Friday.

I have updated all of the Sweet 16 forecast models for Q2 results and changes of their guidance.
Updated profiles for AR, CLR and RSPP are now on the EPG website.
We will update the rest of the Sweet 16 profiles this month.

An updated Sweet 16 spreadsheet showing my valuation for each company, compared to FC price targets, will be posted to the EPG website on Saturday evening.

[dan_s]

The Sweet 16 is a carefully selected portfolio of rock solid upstream oil & gas companies. I work hard to screen the companies that go into the Sweet 16 and I have a HIGH level of confidence in my forecast models for them. They all have a strong base of production and proven reserves. They all have valuable undeveloped leasehold and years of growth locked in. This is where the bulk of your portfolio should be invested.

Small-caps may have more upside, but they also have a lot more RISK.