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SM Energy 2Q Production Beats Expectations; Costs Falling

Denver-based SM Energy Co.'s second quarter results beat expectations on earnings per share (EPS) and production. Performance in the Eagle Ford Shale and Williston Basin is improving, and costs are falling faster than expected. However, like others these days, the company posted a net loss.

"Production came in ahead of budget, primarily as a result of strong well performance in both the Eagle Ford and Williston Basin as completion optimization is driving production performance above our type curves," CEO Jay Ottoson said. "Further, a number of new wells in our Eagle Ford East area downspacing test program came into sales during the quarter with strong early production results."

Production during the second quarter was 16.5 million boe, or 181,000 boe/d, up 23% compared with 13.4 million boe, or 147,000 boe/d, in 2Q2014. This beat guidance by about 500,000 boe. A sequential quarterly decline in production from 16.8 million boe was primarily due to planned third-party maintenance in the Eagle Ford, which was completed on schedule, management said.

Company-wide, production mix for the quarter was 45% natural gas, 31% oil and 24% natural gas liquids (NGL). Production from Midcontinent assets sold during the quarter totaled 677,000 boe (96% natural gas).

Realized commodity prices were, of course, down during the quarter, reflecting a 44% decline in West Texas Intermediate oil prices and a 41% decline in New York Mercantile Exchange natural gas prices from the prior-year period. SM Energy had about 46% of oil production, 41% of gas production and no NGL production hedged during the quarter.

During a conference call with analysts Wednesday, Ottoson said costs are "way down" and continuing to fall. Lease operating expenses (LOE) in the latest period were $3.26/boe and transportation expenses were $5.64/boe, down sequentially and from a year ago, with costs lower than budgeted. "The overall operating cost environment has improved at a more rapid pace than expected at the beginning of 2015," the company said.

Ottoson said unit LOE was  "significantly below our forecast" due to improvements in recently acquired properties in Divide County, ND, and generally lower costs across all producing assets. "In combination, strong production and lower costs drove very strong EBITDAX [earnings before interest, taxes, depreciation, amortization and exploration expense] for the quarter. The balance sheet was further supported by completion of our Midcontinent asset sales that generated net proceeds of approximately $317 million [see Shale Daily,Jan. 7]. The company ended the second quarter with $12 million drawn on its $2.4 billion revolving credit facility and total debt of 1.7 times (trailing 12 month) EBITDAX."

The CEO noted during the conference call that SM Energy enjoys less leverage than a number of its peers. At the end of the quarter, long-term debt was $2.47 billion including $2.35 billion in senior notes.

However, SM Energy posted a net loss for the quarter of $57.5 million (minus 85 cents/share), compared with net income of $59.8 million (88 cents/share) for the year-ago quarter. Adjusted net income for the second quarter was $33.2 million (49 cents/share), compared with $106.5 million ($1.56/share) in the second quarter of 2014.

Adjusted EBITDAX was $337.3 million, compared with $423.4 million in the second quarter of 2014, down because of commodity prices.

The 2015 drilling program is focused in the Eagle Ford shale and Bakken/Three Forks plays with four rigs active in the Eagle Ford, four in the Bakken/Three Forks and one in the Powder River Basin. This fall two Bakken/Three Forks rigs are expected to be let go.

In the Eagle Ford, second quarter production averaged 130,800 boe/d net, including both operated and nonoperated wells. Production was affected by planned shut-ins, predominantly due to third-party maintenance at gathering facilities; however, production exceeded expectations due to improved well performance. Current well costs are down more than 30% compared with similarly designed wells in 2014.

Second quarter production from the Bakken/Three Forks program averaged 24,100 boe/d, 86% weighted to oil. SM Energy has moved to plug-and-perf/cemented liner completions in the program, and these are demonstrating improved well performance compared to prior completion techniques, it said. At the end of June, the company had 37 drilled but uncompleted wells in its operated program.

Cumulative production from nine wells (including five new wells) in Divide County testing the Bakken interval is continuing to perform above the company's type curve expectations for the Three Forks interval in the area, it said. "The addition of the Bakken interval has the potential to significantly increase the company's proved reserves and inventory of drilling locations in Divide County."

Spending so far is about $50 million above the original budget due to partner non-consents and higher than expected partner operated costs during the first half of the year, Ottoson said. "We anticipate significantly lower capital spending in the second half of 2015 of approximately $460 million for the six-month period as we further reduce the rig count to seven and benefit from realized declines in drilling and completion costs," he said.

"Looking forward through 2015, we have raised the midpoint of production guidance and significantly lowered lease operating expense guidance. We expect to prove-up additional inventory in our Eagle Ford and Williston Basin play areas while ending the year without accumulating additional debt." 

On the earnings news, investors sent SM shares up more than 8% in midday trading Wednesday, while analysts praised the production and EPS beat.

"We continue to see tremendous upside from the stacked pay potential in the Eagle Ford (as many as two Upper Eagle Ford targets and two Lower Eagle Ford targets) and enhanced completions methods in both the Bakken and Eagle Ford, with additional results expected later this year," wrote Topeka Capital Markets analyst Gabriele Sorbara.

BMO Capital Markets analyst Phillip Jungwirth, who rates SM Energy "outperform," wrote that the company is "well positioned for 2016." David Tameron at Wells Fargo Securities noted the company's "solid" financial liquidity with a minimal amount drawn on its revolver. Tameron rates SM Energy shares "market perform."

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