SM Energy Asset Sale Energizes the Bulls

January 10, 2018 by Paul Ausick

Last year was a harsh one for SM Energy Co. (NYSE: SM). The stock dropped about 35% as the Denver-based company struggled with low crude oil prices through the first half of the year and only recovered slightly when prices began rising.

When the company reported third-quarter results in November, the CEO mentioned that expected cash flow growth would take time, but the company wanted to speed up the process by selling noncore assets. SM revved up its divestment energy Wednesday morning.

The company announced the sale of about 112,000 acres in the Powder River Basin for $500 million in cash. The sale includes about 80% of the company’s assets in the region. The buyer was not identified and SM expects the transaction to close this quarter.

CEO Jay Ottoson said in this morning’s announcement:

Divestiture of these assets is consistent with our strategy of focusing on development of our top tier Midland Basin and Eagle Ford assets and improving our balance sheet by reducing debt. Pro forma for this transaction, as of the end of the third quarter 2017, net debt is reduced by approximately 20% and net debt:EBITDAX is reduced to less than 3 times.

Net production from the region in December was approximately 2,200 barrels of oil equivalent per day (51% oil, 18% natural gas liquids, 31% natural gas) with proved reserves of 4.2 million barrels of oil equivalent.

Analysts at Williams Capital noted that the deal pushes SM closer to a pure-play Texas company, consistent with the company’s strategy of focusing on its core Midland Basin and Eagle Ford shale assets.

Merrill Lynch raised its price objective on SM from $26 to $30, noting that proceeds from the sale will help “bridge projected cash outspend while improving leverage profile.”

Credit Suisse said that the PRB sale unlocks underappreciated value and adjusting for the 2,200 barrels of daily production valued at $40,000 a barrel, the acreage was sold for approximately $3,700 per net acre, a price the firm called “attractive given it was not even in our [net asset value calculation] due to limited operated activity and well disclosure since 2014.” The firm’s analysts raised their price target from $27 to $30 with an Outperform rating and elaborated:

The sale is positive for the PRB overall, which has garnered increasing attention from public (CHK, EOG & DVN) and PE-backed privates given technological advancements. SM has been prudent to de-risk the asset using third-party JV capital, and now bring forward the value to de-lever and fund the Permian development. The sale reduces its YE18 & YE19 net debt/EBITDX to 2.8x and 2.2x from 3.3x and 2.6x, respectively, based on current strip prices. We expect proceeds to be used to bridge the 2018 funding gap, though we could see ~$15MM interest saving from redemption of 2021 notes.

Other analyst firms also raised their price targets. RBC Capital Markets raised its target from $23 to $24 and Stifel raised its price target from $44 to $46.

SM stock traded up as much as 5.5% at $27.60 before sliding back to trade at around $27. The stock’s 52-week range is $12.29 to $35.29, and the consensus 12-month price target is $27.62.