SM Energy: Delayed Well Completions Affect H2 Production Expectations

SM Energy (NYSE:SM) reduced its expectations for 2H 2022 production by close to 10,000 BOEPD due to delays in well completions and higher than expected impacts from offset activity. This (combined with weaker natural gas prices) has reduced my estimates of its 2H 2022 free cash flow by around $200 million compared to mid-September.

As a result, I have reduced my estimate of SM’s value by several dollars and now believe that it is worth in the high-$40s at long-term (after 2023) $70 WTI oil and $4 NYMEX gas.

Lowered Production Expectations

SM Energy reported weaker than expected (preliminary) Q3 2022 production volumes. It mentioned that its wells have been performing slightly better than expected, but that September production volumes were negatively affected by delayed well completions (blamed on supply chain issues) as well as higher than expected impacts from offset activity. SM reported an average of 137,800 BOEPD in production for Q3 2022, down -6% from the 146,600 BOEPD it averaged in Q2 2022.The completion delays and impact of offset activity are also expected to lower Q4 2022 production below previous expectations. At the midpoint of its full-year guidance, SM now expects to average around 140,500 BOEPD in Q4 2022.

This has resulted in SM revising its full-year production guidance to approximately 144,000 to 145,000 BOEPD. This is down approximately 5,000 BOEPD from its prior guidance for an average of 148,000 to 151,000 BOEPD in 2022, although it is also in-line with its initial 2022 guidance for 140,000 to 148,000 BOEPD. That initial 2022 guidance was with a lower capex budget (around $750 million) compared to current expectations for $870 million to $900 million. The bulk of that increase was due to cost inflation.

Revised 2H 2022 Outlook

SM now appears to expect to average around 139,150 BOEPD in the second half of 2022. This results in a projection that it can generate around $1.566 billion in oil and gas revenue in 2H 2022 at current strip of approximately $90 WTI oil.

SM’s 2H 2022 hedges have an estimated value of negative $314 million.

Type	Barrels/Mcf	$ Per Barrel/Mcf	$ Million
Oil	11,521,620	$89.50	$1,031
NGLs	3,840,540	$35.50	$136
Gas	61,448,640	$6.50	$399
Hedge Value			-$314
Total			$1,252

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SM is currently projected to generate around $361 million in positive cash flow in 2H 2022 before its dividend payments. This is around $200 million than less than what I had projected for SM around a month ago. A bit over half of the reduction is due to SM’s lower production volumes, while the rest is due to weaker (net of hedges) commodity prices (with natural gas prices falling sharply compared to mid-September).

	$ Million
Lease Operating	$131
Transportation	$82
Production and Ad Valorem Taxes	$94
Cash G&A	$48
Cash Interest	$51
Capex	$485
Dividends	$18
Total	$909

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SM is now projected to end 2022 with approximately $975 million in net debt, before spending on share repurchases.

Notes On Valuation

I’ve reduced SM’s estimated value to around $48 to $49 per share in a scenario with 2023 commodity prices following current strip of high-$70s WTI oil and $5.10 NYMEX gas, before end up at long-term prices of $70 WTI oil and $4.00 NYMEX gas.

SM’s wells have still been performing at or slightly better than expectations, so the longer-term value of its assets remains unchanged. However, the combination of reduced near-term production and lower commodity prices has a fairly significant effect on the cash flow projections to the end of 2023. Thus, I have reduced its estimated value to account for that.

Conclusion

SM Energy reduced its expectations for 2H 2022 production by nearly 10,000 BOEPD (from its updated mid-year guidance) due to supply chain issues delaying well completions and higher than expected impacts from offset activity. SM’s wells have continued to perform at or above expectations, so its full-year production still looks likely to end up in the middle of its original guidance range that it gave near the beginning of 2022.

Weaker near-term commodity prices plus the lowered 2H 2022 production level combine to reduce my projections for SM’s free cash flow (until the end of 2023) by around $3 to $4 per share. Thus, I’d now value it in the high-$40s at long-term (after 2023) $70 WTI oil and $4 NYMEX gas.