SM SM Energy Company

SM Energy Company’s (SM) second-quarter 2011 profit recorded a substantial jump on higher production, divestiture operation as well as higher price realization. The company reported second quarter adjusted earnings of 91 cents per share, handily beating the Zacks Consensus Estimate of 54 cents and showing a significant improvement from 16 cents earned a year earlier.

Total revenue of $377.9 million leaped 78.5% from $211.7 million in the prior-year quarter and comfortably surpassed the Zacks Consensus Estimate of $301 million. Oil, gas and natural gas liquid (NGL) production revenues contributed $333.9 million (up almost 90% year over year) to the total revenue.

Operational Performance

The company’s second-quarter production came in at 436.9 million cubic feet equivalent per day (MMcfe/d), up a considerable 58% year over year, and ahead of management’s target range of 396–429 MMcfe/d.

SM Energy produced 262.7 million cubic feet per day (MMcf/d) of natural gas in the quarter, reflecting a 43% year-over-year growth. Oil production also climbed 31% year over year to 20.4 thousand barrels per day (MBbls/d). Natural gas liquid contributed 8.7 MBbls/d to the total volume.

Including the effect of hedging, average equivalent price per thousand cubic feet (Mcf) was $7.89 compared with $7.36 in the year-ago period. Average realized prices (inclusive of hedging activities) were $5.01 per Mcf of natural gas and $84.40 per barrel of oil, down 10% but up 30%, respectively, from the comparable quarter last year.

On the cost front, unit lease operating expense (LOE) decreased approximately 27% year over year to 84 cents per Mcfe in the quarter. Transportation expenses increased substantially to 42 cents per Mcfe (from 20 cents in the year-ago period); general and administrative expenses were 69 cents per Mcfe (down 32%); while depletion, depreciation and amortization (DD&A) expenses decreased 9% to $2.90 per Mcfe from the year-earlier level of $3.17 per Mcfe.

Liquidity

Operating cash flow improved to $226.7 million during the quarter from $119.2 million in the year-ago quarter. At the end of the quarter, the company had cash balance of $101.1 million and long-term debt of $630.3 million, with debt-to-capitalization ratio of 32%.

Guidance

SM Energy raised its 2011 production guidance to a range of 162–167 billion cubic feet equivalent (Bcfe) from the prior expectation of 146–152 Bcfe. The guidance represents a year-over-year growth of 47–52%. For 2012, the company also provided preliminary production forecast in the range of 225–232 Bcfe, anticipating a year-over-year growth of 35–40%.

LOE expense per Mcfe will likely be in the range of 90 cents to 96 cents and 88 cents to 93 cents for the third quarter and full year, respectively. The company also expects DD&A to remain in the $2.90–$3.10 range for the third quarter as well as full year.

SM Energy boosted its capital budget to $1,550 billion from its prior expectation of $1,080 billion for 2011, to reflect continued drilling activities in the company’s operated Haynesville shale position in East Texas until its leasehold position is held by production in 2012. The company’s preliminary 2012 capital spending is expected to remain within $1,400–$1,500 million.

Outlook

Denver, Colorado-based oil and gas company, SM Energy remains proactive in its attempt to hold a significant position in emerging shale plays and focus more on resource, with an inventory of repeatable drilling prospects and a high rate of return. We believe that the company’s emerging core portfolio is a positive catalyst for visible organic growth over the next several years.

During the quarter, SM Energy initiated negotiations regarding the divestiture of a large portion of its Eagle Ford Shale assets. The arrangements are a part of SM Energy’s objective to offload approximately 20% to 30% of its total 250,000 net acre Eagle Ford Shale position. We believe these divestitures will help the company to streamline its portfolio while holding a significant position in emerging shale plays.

However, our long-term Neutral recommendation stems from SM Energy’s natural gas-weighted reserves. The company derives a significant portion of its operating revenues from natural gas. Consequently, it may face near-term headwinds in this sector on the back of struggling commodity prices.

SM Energy’s competitor, Range Resources Corporation (RRC) also reported stellar second-quarter 2011 earnings piggybacking on higher production level, realized prices along with lower unit costs.

We currently retain our long-term Neutral recommendation on SM Energy. The company holds a Zacks #3 Rank, which is equivalent to the short-term Hold rating.

 
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