imaginima
SM Energy (NYSE:SM) announced a $500 million share repurchase program as well as an increase in its dividend to $0.15 per quarter (or $0.60 per year). SM is able to do this since it hit its leverage ratio target (leverage of 0.7x at the end of Q2 2022) and is also expected to generate over $500 million in positive cash flow over the second half of 2022.
As I expected, SM’s debt reduction has led to that return of capital to shareholders. SM is now trading closer to what I think it is worth, but it still should have upside into the mid-$50s in a long-term (after 2023) $70 to $75 oil scenario along with $4 to $4.50 natural gas.
Return Of Capital To Shareholders
SM recently announced a plan to return capital to shareholders that it believes is sustainable at $60 oil and $3 natural gas. It has increased its current minimal ($0.01 per share semiannually) dividend to a $0.15 per share quarterly dividend. This will first be paid on November 7, 2022 to owners of record at the close of business on October 25, 2022.
SM also is now authorized to repurchase up to $500 million of its stock through the end of 2024. At its current share price, SM could repurchase 10.7 million shares, or around 9% of its outstanding share count.
Increased Production, Costs And Capex Budget
SM revised its guidance for 2022, with increases to production, costs and its capital expenditure budget.
SM originally expected approximately 144,000 BOEPD in production during 2022 and boosted its production expectations to 149,500 BOEPD as a result of better than expected well performance in the Midland Basin and South Texas.
It also increased its capital expenditure budget from $750 million to a range of $870 million to $900 million. Close to $100 million of that increase was due to inflationary pressure, while another roughly $40 million was due to SM’s decision to retains its current rig and pressure pumping crews through the end of 2022. That decision will positively impact production in early 2023.
SM is also expecting a modest amount of inflation with its lease operating expenses, boosting its LOE guidance by approximately $0.20 per BOE despite its strong well performance.
I believe the guidance changes are neutral overall, with the increased production balancing out the higher costs.
2H 2022 Outlook At Current Strip
Based on the midpoint of its full year guidance, SM expects to average approximately 149,000 BOEPD (46% to 47% oil) in the second half of 2022.
At current 2H 2022 strip of $91 to $92 WTI oil, SM is projected to generate $1.479 billion in revenues after hedges (which have negative $363 million in value for the second half of the year).
| Type | Barrels/Mcf | $ Per Barrel/Mcf | $ Million |
| Oil | 12,742,500 | $91.00 | $1,160 |
| NGLs | 4,104,100 | $35.00 | $144 |
| Gas | 63,320,400 | $8.50 | $538 |
| Hedge Value | -$363 | ||
| Total | $1,479 |
After factoring in the cost inflation and increased capex budget, SM is now projected to end up with $561 million in positive cash flow in the second half of 2022 before dividends. SM’s new $0.15 per share quarterly dividend will first be paid out in November 2022 and results in $18 million per quarter in dividend payments.
| $ Million | |
| Lease Operating | $136 |
| Transportation | $88 |
| Production and Ad Valorem Taxes | $110 |
| Cash G&A | $48 |
| Cash Interest | $51 |
| Capex | $485 |
| Dividends | $18 |
| Total | $936 |
SM had $1.318 billion in net debt at the end of Q2 2022, so it may be able to reduce this to around $775 million at the end of 2022 now, before any impact from share repurchases.
Estimated Valuation
I estimate SM’s value at around $52 to $53 per share in a scenario where 2023 commodity prices are around current strip (low-$80s WTI oil and $6.65 NYMEX gas) before reverting back to long-term $70 WTI oil and $4.00 NYMEX gas.
At long-term $75 WTI oil and $4.50 NYMEX gas instead, SM’s estimated value improves to approximately $57 to $58 per share.
I am valuing SM at a 3.5x EV to EBITDAX (using long-term prices) multiple and assuming that it can grow production by low-to-mid single digits in 2023.
Conclusion
SM Energy is now able to offer a larger dividend (increased from $0.02 to $0.60 per year) and institute a share repurchase program now that it has made a substantial amount of progress with debt reduction. It appears capable of generating over $500 million in positive cash flow over the second half of 2022 despite some cost increases.
SM’s wells have been performing well, resulting in an upward revision to its production guidance. I’d estimate SM’s value to be in the mid-$50s in a long-term (after 2023) $70 to $75 WTI oil scenario, along with $4.00 to $4.50 NYMEX gas.
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