SM - SM Energy: Now Projected To Generate $350 Million FCF In 2023

2023-03-27 23:13:43 ET

Summary

• SM is projected to generate $350 million in free cash flow in 2023 at current strip of approximately $73 WTI oil and $2.75 NYMEX gas.
• It is growing production by around 1% compared to 2022, but its oil production may decline by 4%.
• SM expects a reduction in South Texas natural gas transportation costs that may save it around $23 million per year starting in July.
• SM also exited 2022 with $445 million in cash on hand, so it has a fair bit of money for share repurchases and note repurchases.

SM Energy ( SM ) looks capable of generating around $350 million in free cash flow in 2023 now at current strip prices (roughly $73 WTI oil and $2.75 NYMEX gas). SM's oil cut is relatively low at 43%, so it has been fairly affected by the decline in commodity prices for NGLs and natural gas. The prices for those commodities have declined by a larger percentage than oil.

SM expects its 2023 production to grow by around 1% from its 2022 production levels, which is roughly what I had expected before . SM's oil cut is a fair bit lower than I anticipated though, as I had believed it would focus more development capex on its oilier assets given the relative strength of oil prices compared to NGLs and natural gas.

SM had $445 million in cash on hand at the end of 2022, so combined with its post-dividend free cash flow it would have $722 million (by the end of 2023) to put towards share repurchases and note redemptions.

I estimate SM stock's value at approximately $41 per share in a long-term $70 WTI oil and $4.00 NYMEX gas environment.

Notes On Production

SM expects its production to average approximately 147,000 BOEPD in 2023 with a 43% oil cut. This would be slight production growth, with average daily production up around 1% from SM's full-year 2022 average daily production and 3% from its Q4 2022 average daily production.

In terms of oil production, SM expects 2023 daily oil production to be around -4% compared to its full-year 2022 daily oil production and +2% compared to its Q4 2022 daily oil production.

SM's production in South Texas has a relatively low oil percentage (21% oil, 34% NGLs and 44% natural gas in Q4 2022), so that has been relatively hard hit by the low prices for non-oil commodities. Its South Texas cash production margins for 2023 could end up at around $20 per BOE or less given current strip.

Outlook For 2023

With 147,000 BOEPD (43% oil) in average 2023 production, SM Energy would be able to generate $2.189 billion in revenues before hedges at current strip of around $73 WTI oil and approximately $2.75 NYMEX gas.

SM's 2023 hedges have approximately $44 million in positive value at those commodity prices. It has hedges covering approximately 29% of its oil production and 28% of its natural gas production.

SM expects a capex budget of approximately $1.078 billion excluding capitalized interest. I've chosen to put SM's cash interest costs as one line item. SM's capex budget also includes $45 million for facilities, which includes the extension of the South Texas oil facilities.

SM notes that is South Texas natural gas transportation costs are expected to decrease by $0.35 per Mcf starting in July 2023. South Texas accounts for approximately half of SM's total natural gas production, so this will save SM around $23 million per year on an annualized basis.

At current strip, this results in projected free cash flow of $350 million for SM in 2023.

SM's current quarterly dividend is $0.15 per share, which adds up to approximately $73 million in dividend payments per year. This leaves $277 million for debt reduction and repurchasing shares. In addition, SM had $445 million on cash on hand at the end of 2022 that it could also put towards those items.

Estimated Valuation

I now estimate SM's value (for the end of 2023) at $41 per share in my long-term $70 WTI oil and $4.00 NYMEX gas pricing environment. SM's value has been reduced from my earlier $47 per share estimate due to reduced free cash flow expectations in 2023 as well as a lower oil cut than what I had previously modeled.

If SM put all its post-dividend free cash flow towards debt reduction in 2023 it would end the year with approximately 0.6x leverage. SM looks to be in good shape financially still despite the drop in commodity prices.

Conclusion

SM appears to be on track to generate approximately $350 million in free cash flow in 2023 at current strip prices, despite weak natural gas prices (with natural gas making up 41% of its total production).

SM's 2023 production is expected to be up 1% from its 2022 production, but its oil production is expected to decline by 4% at guidance midpoint.

Since SM exited 2022 with $445 million in cash on hand, it has plenty of funds (combined with 2023 free cash flow) to put towards share repurchases and note repurchases. I estimate its value at $41 per share in a long-term $70 WTI oil and $4 NYMEX gas environment, which is decent upside from its current share price.

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