December 14, 2010 - 6:37pm EST by
2010 2011
Price: 54.06 EPS $1.10 $1.35
Shares Out. (in M): 65 P/E 0.0x 0.0x
Market Cap (in $M): 3,409 P/FCF 0.0x 0.0x
Net Debt (in $M): 275 EBIT 0 0
TEV ($): 3,683 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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SM Energy is a short because it doesn't control its own destiny with its capital, has over-rated acreage, is dependent on massive and continuous asset sales to hit targets, and is effectively trading at the net asset value of its assets.  Like most E&Ps, SM doesn't show much discipline in its capital budget as it openly is guiding to a cash shortfall of $600mm next year at 85 oil and 5 gas (that's 20% of the market cap).  This is not a 1 year phenomenon as it will continue in 2012.   If commodities weaken from there, the gap accelerates and a clean balance sheet that will lever up as its would quickly become stressed (this company is already a high yield issuer despite having only $250mm of preferred stock on its balance sheet in terms debt).



The company has guided to $1bln of capital in its plan for 2011 since the middle of 2010.  The majority of this will be in 2 plays called the Eagle Ford in South Texas and the Bakken in Montana. Both plays are decent but especially in the Eagle Ford, there has been rampant cost inflation (at least 25% and in some cases 50%) in drilling and completion costs.  As such, I doubt that $1bln will get the same growth that it would have 6 months ago and I believe that we'll either see a capex increase of a production growth decrease at some point this year.  Not least, the company is the non-operated partner in a significant portion of its play with Anadarko which means that as Anadarko spends, so must SM else they give up the acreage.  In total, the company has $700mm in minimal capital commitments next year.


Asset sales:

To company has guided to $300-$600mm in asset sales to bridge its 2011 cash flow gap. They have specifically called out selling their Marcellus acreage (natural gas) and some producing properties but I believe investors have erroneously assumed that they'd meet their $300-$600mm target through these 2 asset sales.  Not only do I not think the Marcellus sale is a slam dunk, but I believe the company will need to sell significantly more acreage to hit their asset sale targets in 2011 and 2012 will bring an equally large free cash shortfall. 


Often, E&Ps trade below their NAV and asset sales are therefore accretive; however, in this case I believe the company is actually trading close to its NAV so the asset sales have more likelihood of disappointing investors than being accretive.  This is a company that needs to sell assets to hit their targets; it is not doing so out of a plan to unlock value.  Not least, while many of its assets are in the "right play", in much the acreage is sub-optimal.  I'll spare the detail here but the well data in the Eagle Ford has been disappointing at best, relative to competition.  I'm also highly skeptical of their Niobrara acreage which is an unproven play where each company's specific acreage is highly variable.


Bull case:

The bull case is that this is a company with many catalysts via asset sales that is growing 20% yoy next year and making a shift to more oily assets.  In addition, some competitors' wells in near by acreage have had a very good well and so the NAV is going higher as the results come in.  I actually think the market is mistaking how much assets the company actually has to sell to fill the 2 year gap it is staring at. In addition, I believe the proceeds of the asset sales will highly the below average quality of the acreage.  Ultimately, I do think SM will sell assets and bring in significant proceeds but investors will be left with an inferior company with much less of a shift to oily assets.  With regard to the competitors' well results, those results were from wells that cost 40% more and based on publically disclosed well data, the SM wells are significantly below average.


-disappointing asset sales
-debt increasing
-capex increases or production decreases
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