Another energy company that declined substantially during the last few months is SM Energy (SM). Again, the strategy initially purchased SM Energy in late 2008/early 2009 at substantially lower prices than even its currently depressed price. SM is an exploration & production company that derives approximately 75% of its production from Texas (primarily the Eagle Ford Shale area), 15% from the Rocky Mountain region (primarily Bakken/Three Forks area in North Dakota), and the remainder split between the Permian Basin in west Texas and the Mid-Continent in Oklahoma.
Revenues from oil represented roughly 55% of the total June quarter revenues, with natural gas and natural gas liquids (NGLs) generating 28% and 17% of the revenues. SM Energy is currently earning roughly $20 per share of ebitda and is trading close to 4x enterprise value to ebitda, versus Athlon Energy that just announced its being acquired at roughly 15x ebitda. Granted, the recent decline in oil prices will negatively impact SM’s near-term revenues and profit. However, assuming no growth in production from the June quarter level and no additional hedges were put in place this quarter (SM will report Q32014 results on October 29th), SM has roughly 50% of its 2015 oil and gas production hedged out at approximately $90/barrel and $4.00/mcf.
Besides reducing the risk to shareholder profits from lower commodity prices by hedging out some of its future production, SM also boasts among the lowest finding & development (F&D) cost for US shale oil producers. We estimate SM’s F&D costs at about $13/barrel, which allows the company to have a much lower break-even cost than many highly levered U.S. shale producers. SM’s strong balance sheet gives the company the option to purchase good oil & gas assets from potentially distressed sellers, should oil prices fall below $75/barrel.
Both RDC and SM are representative of our investments in energy companies. That is, our investments are in companies with strong balance sheets, seasoned management teams, and good prospects to generate strong financial results despite oil prices declining $20/barrel from its recent level of approximately $105. There has been too much capital spending on tertiary U.S. shale oil projects over the past few years. High oil prices and cheap capital seduced many investors into businesses that they do not understand, nor do many of these companies have the capital to weather the inevitable down cycles.
From FPA Capital Fund (Trades, Portfolio) Q3 2014 Commentary.
