Sanchez Energy - Aggressive Spending Could Lead To Future Trouble

| About: Sanchez Energy (SN)

Summary

Sanchez Energy has plenty of liquidity and cash on hand currently. It likely will have enough cash to maintain production until 2018 without needing to access its credit facility.

However, just because it has plenty of cash doesn't mean that it should spend it. Current spot prices mean that Sanchez is likely only netting $6 per BOE.

It would make most sense for Sanchez to restrict its capital spend to below production maintenance levels until prices make at least a partial recovery.

Spending $250 million to $300 million on CapEx per year could leave its common shares having little value in 2018 even with $60 oil and $3 natural gas then.

Analyst and investor day event will shed important light on its plans.

Sanchez Energy (NYSE:SN) is a reasonably strong position financially at the moment, with a significant amount of cash on hand, as well as no borrowings under its credit facility. However, it also has a large amount of unsecured debt and requires much higher oil and gas prices to reach breakeven cash flow.

The future value of Sanchez's shares will be significantly affected by how aggressive management is with its spending plans in the next year or two. Too much spending in a low oil and gas price environment will potentially land Sanchez in trouble by 2018 and could negate much of the remaining value of its shares. Sanchez's analyst and investor day will shed some valuable light on its plans.

NGL Pricing

It appears that NGL prices have fallen further, which puts Sanchez Energy is a challenging position given that around 33% of its 2016 production is expected to be NGLs. Sanchez Energy realized $11.30 per barrel for its NGLs in Q3 2015, but current realized prices are likely around the $9 to $10 per barrel range.

NGL prices will probably start to recover somewhat as oil and gas production growth stalls or decreases with the challenging market conditions. Wells Fargo does expect a modest rebound in 2016, although its forecast was reduced by 11% from earlier. I've assumed that Sanchez can realize around $12 per barrel for its NGLs in 2016, slightly above its Q3 2015 realizations. This may prove to be somewhat optimistic, so there is some downside risk that could increase Sanchez's cash burn by $15 million to $20 million if prices stay at current levels instead.

2016 Outlook

It appears that Sanchez Energy would be able to generate $561 million in revenue at $40 oil and $2.50 natural gas in 2016. This includes $180 million in hedge value as it now mostly hedged for natural gas. I estimate that Sanchez Energy would be left with approximately $200 million in cash at the end of 2016 under these conditions, including allocating $115 million in spend for its midstream joint venture.

Barrels/Mcf

$ Per Barrel/Mcf (Realized)

$ Million

Oil

5,973,120

$35.00

$209

NGLs

6,159,780

$12.00

$74

Natural Gas

39,198,600

$2.50

$98

Hedge Value

$180

Total Revenue

$561

Having $200 million in cash and an unused credit facility with a $500 million borrowing base and a $300 million elected commitment is a solid position for liquidity. However, Sanchez has no oil hedges for 2017 currently. Thus, $50 oil in 2017 could result in Sanchez burning over $150 million, even with its midstream joint venture commitments completed in 2016. This could leave Sanchez with a minimal cash balance at the end of 2017 and potentially needing to access its credit facility in 2017.

Value Of Common Shares

Although Sanchez Energy appears to have enough cash to last into 2018 without accessing its credit facility, burning too much cash could result in Sanchez's common shares having little value. Sanchez requires roughly $60 oil and $3 natural gas to generate $290 million EBITDA. That would leave its net debt (of just over $1.7 billion at the end of 2017) at 6x EBITDA, which would make its common shares worth a minimal amount by traditional metrics. If the oil remains sub $60 and NGLs are sub $18 into 2018, Sanchez could end up burning over $100 million per year still then, forcing it to utilize its credit facility and making it necessary for even higher oil prices to make its common shares have intrinsic value.

Conclusion

Sanchez Energy has a strong liquidity position currently, but also a significant amount of debt. Sanchez's debt could make its shares worth only a minimal amount at $60 oil and $3 natural gas if it continues to use up its cash position over the next couple years. With spot oil and gas prices, Sanchez is probably grossing only $16 per BOE, meaning that its production margin is probably under $6 per BOE. Without a significant increase in oil and gas prices, Sanchez would be best off to limit its drilling to what is needed to hold acreage and attempt to conserve its cash pile. However, often times companies are quite free spending with the cash they have on hand, so it will be important to see what Sanchez says during its analyst and investor day event.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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