Commentary by Dan Steffens

Transcription

1 Management William D Sullivan, Chairman Jay D Ottoson, President & CEO Wade Pursell, CFO Commentary by Dan Steffens (SM) reported solid operating results in the first quarter of 2016 that generated $1.97 operating cash flow per share. Cash flow from operations in 2016 should be in the $9.00 to $9.50 per share range. This company deserves to be trading at a much higher multiple of CFPS. Production will be lower in 2016 because SM sold some producing assets in June, 2015 and because they are pulling back to a four rig drilling program. This year s program is designed to preserve liquidity and position the company for growth in Most of this year s capital program is being funded by cash flow from operation. They have a large inventory of drilled but uncompleted wells ( DUC ), so they are well positioned to increase production when commodity prices rebound. SM Energy has a solid balance sheet and plenty of liquidity. Their hedges lock in strong cash flow from operations in Since a high percentage of their acreage is now held by production (HBP) their capital spending can be adjusted quite easily.

2 My valuation of SM Energy has consistently been much higher than the First Call 12-month price target. I believe that most analysts are missing the combination of strong leasehold positions in three of the nation s best oil plays, a large inventory of low-risk development drilling locations and very low finding and development costs (under $15.00 per boe for 2014, dropping to $6.35 per boe in 2015) that should have this stock trading at a much higher multiple of cash flow per share. First quarter results in the Permian Basin were better than expected. SM will operate a four rig program through August, Two rigs will focus on the Permian Basin, an area where return-on-investment is positive down to $30/bbl of oil. One rig will remain in the Eagle Ford and one in the Bakken/Three Forks play in the Williston Basin. Their current plan is to drop the Eagle Ford rig by the end of August, but that may change if oil prices move higher. My forecast and valuation assumes that SM ramps up well completions in the 2 nd half of 2016 as oil, gas and NGL prices improve. SM Energy s production mix is approximately 44% natural gas, 25% NGLs and 31% crude oil. I believe natural gas and NGL prices will improve in 2016, no matter what happens to oil prices. Supply / demand for natural gas in the U.S. market will be much tighter heading into the 4 th quarter of this year. 55% of SM s natural gas production for 2016 is hedged at $3.61/mmbtu and 30% of their crude oil is hedged at $88.01/bbl. My Fair Value estimate for SM Energy common stock is $48.00/share As of the date of this report, First Call s 12-month price target is $31.00 Disclosure: I do not have a position in SM and I do not intend on buying or selling it in the next 72 hours. I wrote this profile myself, and it expresses my own opinions. I am not receiving compensation for it from the company. I have no business relationship with any company whose stock is mentioned in this article. Company Overview (NYSE: SM), a Denver-based company, is an independent energy company that explores for and produces crude oil, natural gas, and natural gas liquids onshore North America. The company has leading positions in the Eagle Ford shale and Bakken/Three Forks resource plays that are the focus of its development programs. SM also has smaller delineation and exploration programs in the Powder River Basin, the Permian Basin and in East Texas. The company has built a portfolio of onshore properties primarily through early entry into existing and emerging resource plays. This portfolio is comprised of properties with established production and reserves, prospective drilling opportunities and unconventional resource prospects. SM Energy s strategic objective is to build its ownership and operatorship of North American oil, gas and NGL producing assets that have high operating margins and significant opportunities for additional economic investment. The company pursues opportunities through both acquisitions and exploration. SM is returns focused and seeks to maintain a simple, strong balance sheet through a conservative approach to leverage. As you can see in the chart on page one, other than their bank revolver, none of their debt matures before The management team has both sound big company managerial experience and a track record of steady growth. The management history can be traced back to Anadarko and ARCO. The management is comparably young (in

3 their 50s) and brings entrepreneurial values into the corporate culture, which fit well into the genes of this rapidly growing energy company. SM Energy s financial-driven strategy emphasizes Sustainable Growth and Shareholder s Value. During 2015, the Company added 161 MMBoe of proven reserves, predominantly in its operated Eagle Ford and Bakken/Three Forks program in North Dakota. These reserve additions are a result of high-grading inventory through improved completion designs, better targeting of landing intervals, further delineation of the Bakken formation and further delineation of acreage acquired in late 2014 in both the Bakken and Three Forks intervals. The Company also added 47 MMBoe of proved reserves based on performance revisions, reflecting improved well performance in the Eagle Ford and Bakken/Three Forks programs primarily as a result of completion design enhancements, such as increased sand loading and plug-n-perf design, as well as reductions in operating costs. As

4 a result of improved well performance and higher quality drilling locations, the Company revised its five-year plan to high-grade certain drilling in both the Eagle Ford and Bakken/Three Forks programs, which postponed the drilling of certain previously proved locations beyond five years. This resulted in moving 79 MMBoe of proved reserves predominantly to the probable category, to conform with SEC five-year rule; in effect, recent pilots and testing programs enabled reserve additions in SM s new development plans and deferred proved reserves from previous development plans beyond the 5-year development horizon. In addition, proved reserves were reduced by 117 MMBoe as a direct result of lower SEC pricing at year-end These proved reserves should be added back as oil & gas prices rebound.

5 First Quarter 2016 Highlights Ø 13.4 MMBoe production; production mix includes 31% oil, 25% NGLs and 44% natural gas Ø $182.3 million adjusted EBITDAX Ø $1.0 billion liquidity and flexibility following bank redetermination and new covenants Ø 1,255 net acres added at Sweetie Peck in the Permian Basin, increasing net acreage position to 16,443 Ø Initial Permian wells significantly exceeding type curve expectations for both Lower Spraberry and Wolfcamp B intervals

6 2016 is off to a very solid start. First quarter results were right on plan. The bank redetermination process was completed and affords us approximately $1 billion in liquidity and substantially improved financial flexibility. And, we made favorable long-term investments with the purchase of Permian acreage that expands our Sweetie Peck asset and our repurchase of certain senior notes in the market at a discount. President and Chief Executive Officer Jay Ottoson First quarter production of 13.4 MMBoe, or 147,500 Boe per day, was 31% oil, 25% NGLs and 44% natural gas. Production benefited from strong initial rates from wells in the Company s Permian Basin program, where the Company resumed drilling and completion activity early in the quarter. Production was at the high end of guidance and, as expected, declined 10% sequentially as the Company stopped completions activity in the Eagle Ford from mid-fourth quarter of 2015 through February and redirected capital to the Permian Basin. Production is expected to dip slightly in Q2, and then grow during the second half of 2016 to an exit rate of approximately 150,000 boe per day.

7 Capital expenditures (before acquisitions) in the first quarter of 2016 were $205.4 million. Capital expenditure guidance for 2016 of approximately $705 million remains unchanged with the expectation that capital activity will be greater in the first half of 2016 than in the second half of During the first quarter, the Company recorded acquisition costs of $15.1 million related to the acquisition of acreage in the Permian Basin near the Company s Sweetie Peck assets. Operations Update The Company started the year with six active, operated rigs including two in the Eagle Ford, two in the Bakken/Three Forks, one in the Permian Basin and one in the Powder River Basin. The Company ended the first quarter with four active, operated rigs including one in the Eagle Ford, two in the Bakken/Three Forks and one in the Permian Basin and, subsequent to quarter-end, the Company added a second rig in the Permian Basin. During the

8 first quarter, the company drilled 22 gross/21 net operated wells, completed 11 gross/10 net operated wells and participated in seven net non-operated wells. Areas of Operations Eagle Ford Shale: Operated Region First quarter of 2016 Eagle Ford net production was 10.1 MMBoe of which 7.6 MMBoe was operated and 2.5 MMBoe was third party operated. Eagle Ford production declined 12% sequentially as the Company and its partner in non-operated areas scaled back activity in the fourth quarter of 2015 as a result of low commodity prices. The Company continues to test variations of completion techniques to drive well performance and reduce costs, with recent drill and completion costs down to approximately $4 million per well for multiple 7,000 foot lateral Upper Eagle Ford wells.

9 Bakken / Three Forks First quarter of 2016 Rocky Mountain net production was 2.7 MMBoe and was 81% oil. Regional production included 2.0 MMBoe from the Bakken/Three Forks area with the remainder from the Powder River Basin and other areas. The Bakken/Three Forks continues to deliver solid results with further cost improvements and strong well performance as the Company continues to complete all wells using plug-n-perf technology. Permian Basin First quarter of 2016 Permian Basin net production was 554,000 Boe and was 68% oil. The Company re-initiated drilling and completions activity at Sweetie Peck at the start of the year and plans to allocate approximately 30% of 2016 capital expenditures to the area with primary focus on the Lower Spraberry and Wolfcamp B intervals; however, the Company believes that the Middle Spraberry and Wolfcamp D intervals also offer future upside potential.

10 To date, well results have been very strong. The Company continues to see superior well performance using optimization techniques such as specialized wellbore placement, zipper fracs, high sand loadings and slickwater fluid. Since 2014, the Company s drilling and completion costs in the area have declined approximately 53%. During the first quarter and early second quarter, the Company added 1,255 net acres to its key Sweetie Peck asset for approximately $20 million (approximately $5 million of which will be recorded in the second quarter.) In the current price environment, the Permian Basin provides the strongest returns in the Company s portfolio, while offering substantial upside for reserve growth. We are particularly excited about re-starting our drilling program in the Permian Basin, where we are seeing faster drill times, lower costs and better wells. At our Sweetie Peck asset, we completed six wells year-to-date that have been on production for more than one month, four into the Wolfcamp B and two into the Lower Spraberry, all of which are demonstrating production rates that

11 exceed internal expectations, as well as compare very favorably to regional peers. Top tier execution, combined with a near 10% increase in net acreage during the first quarter, put our key Sweetie Peck asset into focus in President and Chief Executive Officer Jay Ottoson 2016 Guidance Full year 2016 guidance remains unchanged. Second quarter of 2016 production is expected to range between 13.1 and 13.5 MMBoe and is expected to have a commodity mix that is approximately 31% oil.

12 Net Income and Cash Flow Forecast Model (SM) Net Income and Cash Flow (last updated 5/23/2016) ($Thousands) Actual Actual Actual Actual Actual Forecast Forecast Forecast Actual Qtr1 Qtr2 Qtr3 Qtr4 Actual Qtr1 Qtr2 Qtr3 Qtr4 Forecast Forecast REVENUES: Oil, gas and NGL production revenues $2,481,544 $393,315 $441,256 $366,615 $298,719 $1,499,905 $211,823 $365,420 $388,939 $426,908 $1,393,089 $1,878,071 < Forecasts include realized gain (loss) on hedges Gain (loss) on divestiture activity 6,078-35,802 71,884 2,415 4,534 43,031-69, ,021 0 which are broken out on row 24 when actuals Other operating revenue 34,685 8,421 3,006 2, , ,500 2,500 2,500 7,774 10,000 are reported Total Revenues 2,522, , , , ,734 1,556, , , , ,408 1,331,842 1,888,071 OPERATING EXPENSES: Expenses per boe based on May, 2016 SM guidance Lease operating (incl. production taxes) 715, , , , , , , , , , , ,400 < $11.00 / boe (incl prod taxes & transportation) DD&A 767, , , , , , , , , , , ,400 < $16.00 / boe Exploration (Successful Efforts) 129,857 37,407 25,541 19,679 37, ,569 15,273 15,000 16,000 16,000 62,273 64,000 Impairment of proved properties 84,480 55,526 12,914 55, , , , ,785 0 < Non-cash expense Abandonment & impairment of unproved prop. 75,638 11,627 5,819 6, , ,012 2,311 2,500 2,500 2,500 9,811 10,000 < Non-cash expense G&A 134,409 37,615 35,414 30,505 26, ,201 25,370 25,500 25,500 27, , ,000 Stock based compensation 32,694 6,024 7,191 7,277 6,975 27,467 6,868 6,000 6,000 6,000 24,868 24,000 < Non-cash expense Change in Net Profits Plan liability -29,849-4,334-4,476-4,364-6,351-19,525-1, ,260 0 < Non-cash expense Derivative (gain) loss - Realized 23, , , , , , , ,028 0 < Cash paid to SM on hedge volumes during period Derivative (gain) loss - Unrealized -606,783 5, , ,565 1, , , ,800 0 < Non-cash expense Other operating expense 29,118 17,119 10,304 7,166 9,945 44,534 6,932 8,000 8,000 8,000 30,932 32,000 TOTAL OPERATING EXPENSES 1,356, , , , ,307 2,135, , , , ,632 1,932,099 1,826,800 INCOME FROM OPERATIONS 1,165,814-54,435-50,879 32, , , ,725-46,083-29,225 1, ,257 61,271 NONOPERATING INCOME (EXPENSE) Other, net -2, Gain (loss) on extinguishment of debt 0-16, ,578 15, ,722 0 Interest expense -98,554-32,647-30,779-33,157-31, ,149-31,088-32,000-32,000-32, , ,000 NET INCOME BEFORE INCOME TAXES 1,064,699-86,511-98,211-1, , , ,085-78,058-61,200-30, ,542-68,629 INCOME TAXES Current , , Deferred 397,780-33,727-42,493-4, , , ,039-28,101-22,032-10, ,043-24,706 < 36% NET INCOME $666,051 ($53,058) ($57,508) $3,114 ($340,258) ($447,710) ($347,210) ($49,957) ($39,168) ($19,328) ($455,662) ($43,923) Common Stock outstanding 67,535 67,979 67,979 67,979 67,979 67,979 68,078 68,078 68,078 68,078 68,078 68,078 Earnings per share $9.86 ($0.78) ($0.85) $0.05 ($5.01) ($6.59) ($5.10) ($0.73) ($0.58) ($0.28) ($6.69) ($0.65) ($0.77) ($0.85) ($0.78) ($3.18) ($2.60) < First Call's EPS Forecast Operating cash flows + Exploration Expenses $ 1,424,843 $ 258,530 $ 273,546 $ 211,509 $ 173,039 $ 916,624 $ 134,346 $ 141,999 $ 162,212 $ 196,157 $ 634,714 $ 898,371 < Capex for 2016 = $705 million Cashflow per share (before CapEx and row 19) $21.10 $3.80 $4.02 $3.11 $2.55 $13.48 $1.97 $2.09 $2.38 $2.88 $9.32 $13.20 <Fair Value estimate of 4 X 2015 to 2017 CFPS = $ $2.16 $2.07 $2.15 $8.35 $9.15 < First Call's CFPS Forecast First Call >> $ PRODUCTION Natural Gas (mcfp/d) 419, , , , , , , , , , , ,000 Oil (bbls/d) 45,431 58,100 55,900 46,800 47,700 52,125 45,300 45,300 45,000 46,000 45,400 49,000 < Sold assets in Mid-Continent area on June 1, 2015 NGLs (bbls/d) 35,665 43,300 44,200 49,100 41,600 44,550 36,800 35,000 35,000 35,500 35,575 38,000 boepd 150, , , , , , , , , , , ,000 < Guidance for 2016 is 139,350 to 150,270 boepd PRODUCT PRICES 16.6% -16.7% 9.1% < y-o-y production growth Natural Gas ($/mcf) $ 4.61 $ 3.51 $ 3.41 $ 3.22 $ 2.96 $ 3.28 $ 3.02 $ 3.00 $ 3.10 $ 3.20 $ 3.08 $ 3.30 < 55% of 2016 gas hedged at ~$3.61 Oil ($/bbl) $ $ $ $ $ $ $ $ $ $ $ $ < 30% of 2016 oil hedged at ~$88.01 NGLs ($/bbl) $ $ $ $ $ $ $ $ $ $ $ $ < 60% of 2016 NGL hedged at ~$15 Gross Revenue check (prod * ave price) 2,513, , , , ,516 2,000, , , , ,908 1,535,280 1,878,071 < 50% of 2017 gas hedge at $ , , ,000 1,230,000 1,470,000 < First Call Revenue Forecasts do not include impact of hedges Publishing, LLC) and is intended for informational purposes only. Readers are encouraged to do their own research and due diligence before making any investment decisions. The publishers will not be held liable for any actions taken by the reader. Although the information in the newsletters and company profiles has been obtained from resources that the publishers believe to reliable, DMS Publishing, LLC dba Energy Prospectus Group does not guarantee its